Universal life insurance: what is it and how does it work?


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(CNN) –

Life insurance can be an essential part of your financial plan, but that doesn’t mean you should buy the first policy you find. The reality is, there are many different types of life insurance to consider, and some may work better for your needs than others.


For example, if you want a policy that offers a guaranteed death benefit until the day you die, you should focus on permanent life insurance. But even then, there are different types of permanent life insurance policies, and the details within each type of policy can vary even more.

Universal life insurance is a type of permanent life insurance policy to consider, but how does it work? Let’s take a look at the different types of universal life insurance you can buy and the reasons someone might want to buy this type of policy.

Universal life insurance – also called adaptable life insurance – is a type of permanent life insurance policy designed to provide benefits until the day you die. However, this type of policy can be more flexible than a traditional policy whole life insurance policy.

While both life insurance and most universal life insurance policies accumulate cash value, universal life insurance policies generally earn “ a market rate, ” according to the Insurance Information Institute, which is used in part to keep your premiums lower and to add to the cash value portion of the policy.

However, unlike standard life insurance policies, which have fixed premiums for the life of the policy, premiums for universal life insurance can fluctuate depending on the market and the policy’s related investments. That means you may be looking at higher premiums if the market or the investments you choose don’t come out as expected.

Since the policyholder takes more risk with a universal life insurance policy, the cost of a universal life insurance policy is generally lower than with regular life insurance.

One of the attractive features of universal life insurance is its cash value, but what exactly does this term mean and how does it work in practice?

In general, the cash value component describes the investment portion of any life insurance policy, including universal life insurance. To build cash value, insurers put a portion of your life insurance premiums in a separate account, which is then invested over time.

Life insurance policies that build cash value offer options for accessing that money in an emergency.

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Life insurance policies that build cash value offer options for accessing that money in an emergency.

Some people borrow for the cash value of their life insurance policy when they need it for major life events or in an emergency. Others may use it to pay their life insurance premiums later when their income after retirement is lower. Another option is to access some of the cash value of your policy by surrendering it if you no longer want to keep paying for the policy.

A universal life insurance policy that builds cash value can be helpful if you want a pillow on the go. It can also help if the premiums on your policy become difficult to manage, as you can rely on the cash value to extend the policy for a while, even if you stop paying the premiums. But keep in mind that using the cash value in this way will lower your overall death benefit.

Under the umbrella of universal life insurance, you can zoom in on specific types of universal life insurance. Policy options include:

Indexed universal life insurance

This is sort of permanent coverage that offers its own cash value component, but the main difference is where that money is kept. With an indexed universal life insurance policy, you can invest the money in your cash value account and earn interest based on a stock market index, such as the S&P 500. In addition, many indexed universal life insurance policies offer a guaranteed interest rate that promises you will never receive a lower return than that rate.

The main advantage of these types of policies is the fact that you can achieve higher returns over time and you also receive a guaranteed minimum return. You also get tax deferred on the cash value of your policy and a death benefit that does not require federal taxes to be paid by your heirs.

On the other hand, with indexed universal life insurance, your returns can be low if the stock market is not doing well, and your returns will always track an index as your insurer makes money by keeping some of the gains.

Guaranteed universal life insurance

If you are looking for life insurance with nearly lifetime coverage at a lower price, consider guaranteed universal life insurance. Unlike other forms of universal life insurance, there is no cash value component to this type of policy, which means that premiums do not change over the life of the policy.

The downside to that trade-off, however, is that since there is no cash value, your policy will expire when you stop paying the premiums, as there is no pillow to fall back on to cover the cost of the policy.

While the lack of cash value may deter some people from considering this option, keep in mind that the premiums on guaranteed universal life insurance are significantly lower compared to other permanent life insurance options.

Guaranteed universal life can be an interesting ‘middle ground’ for people over 60 to consider whether they previously had a term life insurance policy that expired and do not want to commit to the high cost of a new permanent life insurance policy at retirement stage of their life.

Guaranteed universal life insurance may be an option for those over 60 looking for a new policy at a lower cost.

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Guaranteed universal life insurance may be an option for those over 60 looking for a new policy at a lower cost.

Variable universal life insurance

With variable universal life insurance, you get permanent life insurance coverage that comes with a cash value component. The main difference is that you have the option to put some or all of your cash value in a separate account made up of investments you choose.

This type of life insurance gives your heirs a tax-free death benefit, but it also gives you more control over how the cash value of your policy is invested and managed. This gives you the potential for a much higher return based on how aggressively you invest, but you will also endure the market risk that occurs when you invest in the stock market.

Variable universal life insurance also allows you to pay flexible premiums, so it may sound like it represents the best of all worlds. However, many experts do not recommend variable universal life insurance because of the high costs these policies often require.

Broadly speaking, the two most important types of life insurance are term insurance policies and whole life insurance policies. Term life insurance lasts only a certain amount of time – usually 10 to 30 years – while whole life insurance lasts a lifetime and often has a cash value component.

Universal life insurance typically comes in the form of full life insurance, which means that, like most life insurance, premiums usually cost significantly more than comparable term life insurance as your heirs are guaranteed to receive a death benefit as long as you continue to pay the premiums during the policy.

Term life insurance is also offered occasionally without a medical exam, while life insurance – including most universal life insurance policies – generally requires you to go through physical insurance to be eligible for coverage.

Is universal life insurance a good choice for you? Many people who expect to have lower costs later in life do not need permanent life insurance and should not pay the higher costs associated with a universal life policy. But if you think you do need that coverage and don’t want to worry about getting covered as you get older, consider universal life insurance as an option.

Read CNN Underscored’s guide to all the different ones types of life insurance.

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