What is universal life insurance and how does it work?

Universal life insurance is a form of permanent life insurance that offers a cash-value plan as a saving element along with the death benefit, with low premiums. If the policyholder dies, the beneficiary will receive the death benefit only while the remaining cash-value is kept by the insurance company. Most of the insurance companies offer a flexible premium for universal life insurance, while others demand a single lump-sum premium or fixed premiums.

What is life insurance?

After getting a light introduction to an insurance policy, now it’s the time to apprehend that what is life insurance? Life insurance is a legal contract between an insurer and a policyholder.

According to this agreement, the policyholder will pay the pre-determined amount as premiums, either on an annual or monthly basis and the company will provide a lump-sum of money as a death benefit to the beneficiaries nominated by the policyholder when the policyholder dies. Components of life insurance are insurance premium, cash-value plans, and death benefits. However, a cash-value plan is not provided by Term life insurance.

What are the types of life insurance?

There are two main types of life insurance policies:

Permanent life insurance

A policy that covers the whole life of the policyholder along with the death benefit is called permanent life insurance. It offers a cash-value plan that is a kind of investment. Permanent life insurance has several forms including whole life insurance, universal life insurance, variable life insurance, variable-universal life insurance, guaranteed issue life insurance, and burial life insurance.

Term life insurance

A type of life insurance policy that does not offer a cash-value plan and expires after a certain pre-determined period is called term life insurance. The beneficiary will receive the death benefit if the policyholder dies within that specified term. After the expiry, the policyholder can either renew it or terminate it.

Summary
Life insurance is divided into two main types, permanent life insurance with a cash-value plan and term life insurance that expires after a pre-determined term.

What is universal life insurance?

  • Universal life insurance is a form of permanent life insurance that offers an investment plan in addition to the low premium values as compared to the whole life insurance. One of the most charming aspects of universal life insurance is that the low amount is required to pay as a policy premium to keep the policy in force.

  • However, if the insured dies, beneficiaries will only receive the death benefit and no extra money from the investment portion. Now after making it clear that what is universal life insurance, the next thing is that how many types it consists of and how does universal life insurance work.

What are the types of universal life insurance?

Universal life insurance is different from the term life insurance in the aspect that it offers a cash value plan that is not included in the term life insurance, although both are low budget policies. Universal life insurance is further divided into subtypes:

1. Non-guaranteed universal life insurance

Non-guaranteed universal life insurance is also known as traditional UL insurance. It shares the domain and qualities of whole life insurance, although they both differ in a few aspects.

It can be referred to as an unbundled policy in regards to the fact that, in universal life insurance, funeral or burial expenses, interests on cash-value, and other charges are considered while calculating the premiums and cash-value amounts. Thus, it makes the payment of premiums more flexible.

Cons of non-guaranteed UL insurance

Non-guaranteed universal life insurance policy can cause unexpected damage to the future of policyholders, for example, cancellation due to some tax issues with no refunding of money, or lapse of policy because of insufficient cash value or inability to pay high premiums, etc.

2. No-lapse guaranteed universal life insurance

Although its similar to traditional life policy yet no-lapse guaranteed UL insurance differs in the aspect that there is a guarantee for not increasing the premiums with age or time. If the fixed premiums are being paid, the policy remains in force. It is a relatively advanced type of policy.

Pros of guaranteed UL policy

The main reason for its popularity is that it serves as term life insurance with additional benefits of no expiry after a specific term and no variability in premiums.

3. Indexed universal life insurance

It can either be guaranteed or non-guaranteed and the policyholder has a choice to earn the interest over the money in a cash-value account, based on the index of the stock market, for example, S&P 500. These interest values can rise and fall depending upon the stock market indices.

If indexed UL insurance is non-guaranteed, it shares the same drawbacks as the non-guaranteed universal life insurance does. However, if it’s guaranteed, the policyholder may have chances to earn better interest according to the market.

4. Variable-universal life insurance

A fourth and last type of universal life insurance policy is variable-universal life insurance. It’s the same as non-guaranteed universal life insurance with the exception that policyholders can make a direct investment in the stock market instead of a tie to the index market.

Cons of variable-universal life insurance
Drawbacks of variable universal life insurance are the same as that of non-guaranteed universal life insurance.

Summary
Universal life insurance is divided into four types, non-guaranteed life insurance, guaranteed UL insurance, indexed UL insurance, and variable-universal life insurance policies. All have associated pros and cons.

How does universal life insurance work?

Here is a brief detail about the working of universal life insurance. Premiums of universal life insurance are composed of two components, the first one is the cost of insurance and the second is cash-value that serves as a saving account.

Cost of insurance

  • The cost of insurance is the lowest amount paid as a premium, that is needed to keep the insurance policy in force.

  • The cost of insurance combines several factors, such as mortality expenses, administration charges, policyholder’s risk amount, and some other direct charges that are used to keep the policy active.

Cash-value account

  • The amount that exceeds the cost of insurance, get accumulated in the cash-value account of the insurance policy. With the advent of time, the cost of insurance keeps on increasing as the age of policyholder increases.

  • However, there may be a benefit that cash-value may be accumulated in enough amount that can cover the rise in the cost of insurance.

Summary
UL insurance consists of a cost of insurance, and the money that is extra than the COI gets accumulated in the cash value account that keeps on growing because of the interest accumulation.

Advantages of universal life insurance

  • One of the best benefits of universal life insurance is its cash value account that serves as the savings account.

  • This accumulated money is accessible for the policyholder, without any effect over the pre-determined death benefit.

  • If the insured withdraws the excess portion out of accumulated cash value, the interest money will become taxable and the policyholder will have to pay the tax.

  • However, a unique aspect of this insurance policy is that, if the insured dies, the rest cash value will be retained by the insurance company and the beneficiary will receive the only death benefit.

  • If a policyholder borrows a loan against accumulated cash value money, and that loan is not paid back, it will affect the death benefit.

  • Tax is not implicated over the money that is borrowed from the cash-value account of the universal life insurance policy.

Frequently asked questions

1. Is life insurance taxable?

A person interested in buying a policy is often concerned about the thing that, is life insurance taxable or not? Usually, life insurance is not taxable, except in some special circumstances. For example, if the insured wants to give the death benefit to the beneficiary, after a certain period, money is kept in the company’s account, and interest is accumulated over it.
That interest money is taxable. Similarly, if premiums are paid by the employer on the behalf of the employee, then the money above a certain limit will be taxable as it is considered as the income of the policyholder.

2. What are the pros and cons of universal life insurance?

Before buying universal life insurance, one must know the pros and cons associated with it

Pros Cons
1. More flexible premiums than whole life insurance 1. No guaranteed premiums
2. Cash value rises with the rise in market index 2. If the index is low, the cash value may be decreased
3. As associated with the stock market, chances to grow are high 3. There should be enough cash value to keep the policy in force
4. The loan is available over accumulated money 4. If the loan is not returned, it may lessen the death benefit

3. Does universal life insurance expire?

  • Universal life insurance generally offers a fixed premium over a pre-determined age. If a policyholder lives more than that age, he can still keep his policy by paying the risen amount of premiums.

  • However, if premiums are not paid and the accumulated money in the cash value account also ends, it may result in policy lapse.

  • To keep the policy in force, regular premiums must be paid otherwise it may expire costing the future of policyholders.

4. Is universal life insurance a smart financial investment?

A one-word answer to this question is “No”. If the policyholder aims to invest and he is not much concerned about the death benefit, he should go for a term life insurance as compared to the universal life insurance. It requires large investments for a long period as compared to the term life insurance.

5. What does Dave Ramsey say about universal life insurance?

Variable universal life insurance policies offer no guarantee about the number of cash-value amounts that will be given by them.

According to Dave Ramsey (an American businessman), universal life insurance policies are the worst type of life insurance policies that one can choose. He considers them as worst policies because of the high amounts of management fees associated with them.

Conclusion

  • Universal life insurance is a form of permanent life insurance.

  • It offers low and flexible premiums along with a cash-value plan that acts as a saving account.

  • It is preferred over whole life insurance because of low premiums.

  • In contrast to term life insurance, it doesn’t get expired after a specific term.

  • Universal life insurance is divided into further subtypes and each of them has associated pros and cones.

  • Dave Ramsey considers universal life insurance as the worst type of insurance because of its high management fees.

References
  1. https://www.allstate.com/tr/life-insurance/universal-life-insurance.aspx#:~:text=Universal%20life%20insurance%20is%20a,their%20policy%20to%20maintain%20coverage.
  2. Universal Life (UL) Insurance Definition
  3. What Is Universal Life Insurance? | DaveRamsey.com
  4. Types of Universal Life Insurance Policies
  5. Whole Life vs. Universal Life Insurance

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