Universal life insurance: What you need to know (2024)

Universal life insurance is designed to adapt with you over time. For instance, you can increase premiums if you want to build up your policy or decrease premiums if money is tight — all while keeping your policy in force. If you’re looking for the best life insurance to evolve with your needs, universal life insurance may be worth looking into.

What is universal life insurance?

Universal life (UL) insurance is a permanent policy that has a death benefit and a savings component known as the “cash value” account. Your premiums go toward your death benefit and fees, and a portion gets invested inside your cash value account.

The part that goes toward your death benefit and fees is known as the cost-of-insurance component (COI). The part that goes toward your cash value is known as the wealth-building component.

You can borrow or withdraw from the cash value while you’re alive for retirement, UL premiums, emergencies, home renovations, college tuition and more. The account generally grows tax-deferred. If you take a loan against the funds, you’ll only pay taxes on the balance if your policy lapses. However, if you withdraw more than what you’ve contributed to the account, you may create a taxable life insurance event since some of your withdrawal comes from interest earnings.

Your death benefit typically passes to your beneficiaries tax-free.

Example of universal life insurance

Imagine you’re 30 years old and buy a universal life insurance policy. You choose a death benefit of $1 million. Each month, you pay a $300 premium. Out of that, $240 goes toward your insurance coverage and your carrier’s fees, and $60 goes into your cash value account.

Over time, say the $60 investments grow to $10,000, which you can borrow against, withdraw from or use to pay your premiums while you’re still alive. When you pass away, your beneficiaries will receive the $1 million death benefit. However, if you still have a cash value loan of $4,000 when you pass, the outstanding balance will be deducted from your death benefit before it’s paid out.

How does universal life insurance work?

Universal life insurance lasts your entire life — subject to the policy’s maturity date — as long as you pay your premiums. Compared to whole life insurance, you’re not locked into the same policy and premium payments. You have the power to adjust your premiums up and down, within certain limits, as your needs change.

“Technically, a policyholder can change premiums as often as they like, but it’s wise to work with the issuing insurance carrier or a professional insurance agent to understand the impact,” said Eleanor Johnson, founding principal at Highland Capital Brokerage.

The death benefit of a universal life policy is less flexible. While lowering it might be an option, you typically can’t increase it without a guaranteed insurability rider.

“In practice, most insurance contracts will not allow an increase in death benefit post-contract issue,” Johnson said. “So, a new policy would have to be issued for additional insurance coverage.”

You can also add other riders to customize your policy. Riders vary by insurer, but some common universal life insurance riders include an accelerated death or living benefits rider, a chronic illness rider, a waiver of premium disability rider and an accidental death rider.

Even though universal life insurance is a type of permanent coverage, policies typically include a maturity date. Maturity dates typically range from 95 to 100 years old, depending on the insurer and policy. If the insured reaches the maturity date before passing away, their coverage usually ends and they receive the policy’s cash value. In some cases, the policyholder receives the cash value, and in others, they receive the death benefit. There may be tax implications in either situation.

Types of universal life insurance

There are several types of universal life insurance policies, but these three are the most common:

Indexed universal

With an indexed universal life (IUL) insurance policy, your cash value growth is tied to a stock market index, like the S&P 500. If the index performs well, your policy’s cash value can grow at a higher rate. However, if the index performs poorly, your policy’s cash value may not grow at all. Some insurers may set a guaranteed minimum interest rate, as well as a maximum.

Variable universal

If you have a variable universal life (VUL) policy, you can invest your cash value into various subaccounts. These are similar to mutual funds and can be made up of stocks, bonds or other securities. Your cash value returns fluctuate based on how these subaccounts perform. Because of this, VUL policies could be riskier than other types of life insurance.

Guaranteed universal

Guaranteed universal life (GUL) policies have a guaranteed death benefit that won’t change as long as you pay your premiums and don’t have any outstanding cash value loans. Even if your cash value isn’t enough to cover your monthly premium payments, the policy generally stays in force as long as your balance isn’t zero. However, if your account has insufficient funds, your benefit period may be shortened.

Why do people choose universal life insurance?

People choose universal life insurance because they like the appeal of having lifelong coverage with premiums that can be adjusted as their income or financial situation changes and with a cash value component that can grow over time. It also generally has lower premiums than whole life policies since the death benefit and cash value funds aren’t guaranteed, and you can adjust your premium downward if you need to.

Pros and cons of universal life insurance

Pros explained

• Flexible policies: You can adjust your premium payments up and down as your financial situation changes, which gives you the ultimate flexibility.
• Lifetime coverage: Unlike term life insurance, universal life insurance policies last your entire life as long as you pay premiums and maintain a positive cash value balance. However, a maturity date may apply.
• Cash value component: Universal life insurance policies come with a cash value component that can grow over time and serve as an additional source of savings.
• Potential tax benefits: Your beneficiaries will generally receive a tax-free death benefit when you die. While you’re alive, your cash value growth is tax-deferred, so you don’t pay taxes on earnings unless you pass away before paying off a loan or withdraw the earned interest.

Cons explained

• Complicated to understand: Universal life insurance policies are often complex and have many different options that can feel overwhelming for some policyholders.
• May carry risk: Returns aren’t guaranteed and depend on investment performance. If interest rates drop, your policy’s cash value growth might slow down or reverse.
• Have to monitor cash value account: Your insurance policy could lapse or premiums could increase if your cash value account gets drained.
• Premiums aren’t fixed: Unlike term and whole life insurance, your premiums aren’t fixed for life and may increase over time with inflation or due to poor market performance.