Universal life insurance is an adjustable type of permanent insurance that makes it possible to change the two primary components of your policy: the death benefit and your premium. By making alterations, you can impact the overall cash value of this option. It combines the protections that you would receive with a term life policy while offering the savings account feature that you receive with a whole life plan.
This option is primarily sold in the United States. Under the terms of most policies, the excess of premium payments that are above the current cost of the insurance become credited to the cash value of the policy. Interest is credited each month to this amount. The policy is then debited each month by charges, fees, and policy costs even if no premium payment is made for the month.
Most households use a universal life insurance policy to protect their family finances against their final expenses, such as unpaid medical bills, funeral costs, and cremation or a burial. It can serve as income replacement for surviving dependents, offer debt coverage, or provide estate liquidity or replacement. Some even use it as a way to create a non-qualified deferred compensation plan to create retirement benefits to the policyholder or to their spouse or dependent children.
If you are thinking about purchasing a universal life insurance policy, then these are the pros and cons that you will want to review today.
List of the Pros of Universal Life Insurance
1. This type of life insurance adjusts to fit your financial needs.
The primary advantage that you will receive with universal life insurance is that you can manage it more effectively because it adapts to your current financial situation. If you have more money than expected in your budget, then you can pay a higher premium more frequently than necessary to build more cash value in the plan. When you are running short on cash, then you can pay the premium less often or skip a payment. You can even use the cash value to pay premiums if you cannot do so out-of-pocket at the moment.
2. You do not need to qualify to take a loan out from this policy.
If you have a universal life insurance policy with a significant cash value, then you can take a loan out on that amount without needing to qualify based on your credit. You are not required to repay the loan either, although that may minimize the overall value of your policy if you take advantage of this benefit. Most policyholders will not need to pay income tax on the loan either. Even a partial withdrawal is possible if you want to get cash with canceling the policy in some situations, and this is tax-free as well.
3. It is possible to change the terms of your universal life policy.
When you choose a universal life insurance policy, then you typically have the flexibility available to lower your death benefit at any time. This action makes it possible to suit your financial needs or current life situation. If your original purpose was to replace your income while your children were young, then you could reduce the benefit once they move away from home. You would then likely pay a lower premium, which can help when you are earning less income each month.
4. You can increase the amount of your death benefit if you wish.
Just as you can lower your death benefit to save a few dollars each month on your premium costs, it is possible to raise this payout should your financial situation change as well. This option makes it possible to survive longer financially after you are gone, pay off a larger debt, or even send your kids to college without the threat of student loan debt hovering over their heads.
If you take advantage of this benefit, then you still do not need to worry about taxes on any capital gains that happen. If you experience an increase in cash value, it remains deferred. The only exception occurs if you decide to abandon the policy before maturity and receive funds that were not taxed initially.
5. There are several universal life insurance options from which to choose.
When you decide that universal life insurance is the best way to protect your family, then there are three primary types that are available from which to choose: variable, indexed, and guaranteed.
With variable universal life, you can manage different types of mutual funds through separate accounts with the cash value that your policy built over time. Depending on the performance of the policy, you might owe nothing on some months, but then owe the maximum allowed by the IRS in others.
Guaranteed universal life is not a whole life insurance product, but it is designed to last for your entire lifetime. The policies are priced to a specific age, which can sometimes be as high as 115. This option functions like a term policy, but it will cost you more the further out the age you go.
Indexed universal life insurance is fixed, with returns attached to a specific stock index. You are protected with a zero downside with this option, with a lot of potential to the upside. You just need to review the caps and discounts that may limit the overall growth you experience with this policy option.
6. There are several investment strategy options from which to choose.
You are not forced to blindly accept a specific action for the cash accumulation component of your universal life insurance policy. The policy provider will provide you with several investment strategy options from which to choose, even if you opt for an indexed policy. You typically pick the equity index strategy, term deposits, or a general interest account that is based on the current rates that are available. Then as long as you keep up with at least the minimum premiums for the policy, you will receive coverage for your entire life.
7. You will receive tax deferment options with a universal life insurance policy.
When you decide that a universal life insurance policy is the best option for your finances, then the cash value investment portion and the death benefits are both tax deferred in the United States. That means you or your survivors will not receive a contact from the IRS when there is a payout unless you receive a cash benefit that decreases your death benefit in some way. To avoid any complications, you will want to borrow against your cash accumulation instead of using other options that may be available for a cash out.
8. Most policies do not have contribution limits.
Unlike other financial products that can help you to plan for a retirement or your final expenses, universal life policies do not offer contribution limits when they have the option to build a cash value. That means you can forward extra money to this option if you have already maximized your contributions to an IRA, 401(k), 403(b), or similar option. It allows you to build value in a way that may not immediate impact your tax responsibilities while creating a safety net that you can even use in time should something unexpected happen with your finances.
9. Your policy premium costs are typically lower than other life insurance products.
An indexed universal life insurance policy is one of the most affordable ways to protect against the problems that your final expenses may cause. When there aren’t guaranteed interest rates or growth in the terms of the policy, then there are fewer risks that you must cover with your out-of-pocket expenses. That means you can start building a cash value in a way that is more affordable while still creating a layer of protection that can help your family make it through unexpected circumstances.
List of the Cons of Universal Life Insurance
1. You must pay more than the minimum premium to gain the benefits of universal life.
If you are only paying the minimum premium for your universal life insurance, then you will negatively impact the cash value of the policy. Making the minimum payment will only cover the cost of the policy itself. That means there is no way for you to increase the cash value of this resource. You will still receive the protections needed against your end-of-life expenses, but it will not offer anything more than that.
You will experience this disadvantage if you must skip multiple payments or consistently pay less than what the target premium happens to be for your policy.
2. It is still possible to cause the policy to lapse.
A universal life insurance policy depends on the cash value that you build up with the plan by making your targeted premium payment each month. If you are unable to do so, then the impact of your value will decrease over time. That process occurs faster if you must use this value to cover your premium costs. If your policy runs out of cash value and you do not have the ability to pay the minimum costs out-of-pocket, then it may lapse, and your coverage would come to an end.
3. There are limits to the amount that you can borrow from your policy.
When you want to take out a loan from your universal life insurance policy, then you are limited to the amount of cash value in the policy for what you can borrow. The money that you borrow doesn’t come from your cash value either. It is provided by the insurance company, which will then use what is available in your policy as collateral for the loan. If you don’t repay the amount, then you will need to cover the interest on the amount to prevent your policy from lapsing.
If you do not pay off a loan taking from your universal life insurance policy before your death, then the loan amount and whatever interest was owed is subtracted from the death benefit that your beneficiaries will receive.
4. It takes time to build up enough cash value to make a policy usable.
If your goal with a universal life insurance policy is to use it as an option for cash value, then this option is not usually available within the first few years of its existence. Although some providers will allow you to take a permanent withdrawal of up to 90% of the cash value for whatever it present, this option may reduce your death benefit permanently and subject your finances to income taxes.
It may take 5-10 years before you can start using a universal life insurance policy as a beneficial component to your overall financial picture. If you do not have that amount of time to wait, then a term life policy might be a cheaper option if a death benefit to pay for your final expenses or offer supplemental income to your dependents is your priority.
5. The changes you can make with universal life will adjust potential payouts.
When you make changes to your death benefits through a universal life policy, then your beneficiaries will receive fewer funds upon your death than what you originally planned. Lowering the amount might help your current financial situation, but it may not meet your family’s need for support in the future. That is why trying to balance what you can afford with what may be necessary should something unexpected happen can be a tight rope to walk. There are no set rules to follow with this disadvantage, but most households purchase as much as they can afford to ensure there are no income gaps for their survivors.
6. Increasing a death benefit typically requires a health exam.
Life insurance policies are based on your current health and wellness. If you are in good shape and take care of yourself, then the cost of your policy is minimal when increasing the amount of coverage that you want. If you are overweight or are handling a disease like Type 2 diabetes, then it could be a different outcome. You must go through the underwriting requirements again when deciding to increase your death benefit, which means a medical exam will dictate what your final policy will be.
7. There are no guarantees for a financial gain within the cash accumulation portion.
Some universal life insurance policies are not like whole-life policies that offer a guaranteed interest rate and return. That means the results of your policy are not guaranteed to grow in any given year. Your rate of return is based on the performance of the mutual funds or equity index chosen, so you might never know how much your monthly premium will need to be to cover the basic minimums.
8. Participation rates in universal life are often highly variable.
Some policy providers will limit participation in their universal life policies to reduce the amount of a return that they must provide to individuals. Assuming that limitations are not in place, the rates of participation are still going to be variable each year. That will impact the potential return you receive as well. Let’s say that you receive 6% growth in two consecutive years with an indexed policy. In the first year, you had a 100% rate, but in the second year it dropped to 50%.
That means you would receive a full 6% return for the first year (less fees and expenses) with your universal life plan, but it would become a 2% return the next year because of the drop in participation rates.
9. You will always have your returns be lower than the index or mutual funds.
When you create investments through a universal life insurance policy, then the returns that are possible are always going to be lower than what they would be with an investment outside of this policy. The provider of your policy is always going to keep a portion of the gains because that is how the company earns profits. This issue becomes a significant disadvantage if the overall returns are less than 2%, because that means you will likely see zero growth over that period in your policy. This option provides a level of diversification that can protect your family from the final expenses that you may cause, but it may not maximize how much you could grow your wealth compared to other financial products.
10. It is a suitable option if you require a permanent death benefit.
The only real advantage that a universal life insurance policy offers is a permanent death benefit. If something happens to you within the scope of the terms for payout, then your beneficiaries will receive a payout that can be budgets for a variety of expenses. There are times when this benefit is not necessary. If you are financially independent, do not have dependents that you support, or don’t want to contribute a final amount to a charity of choice, then this expense may not make sense.
The pros and cons of universal life insurance are essential to review because this product is not the best option for every financial situation. As a general rule, younger families typically benefit more from term products, while older households can benefit more from whole-life products, of which a universal policy is included. Be sure to speak with a professional financial advisor and review your entire budget before deciding what type of life insurance policy will protect you the best now and in the future.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.