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What is universal life insurance?
Universal life insurance, or UL, has been described as offering the low-cost death benefit of term life with a cash value component like a permanent policy.
With these types of policies, there is a great deal of flexibility afforded to the policyholder.
How does universal life insurance work?
With universal life, a death benefit will be paid out to a named beneficiary (or beneficiaries) if the insured dies while the policy is in force.
The policyholder can also build up the cash value portion of the policy on a tax-deferred basis. This means that there are no taxes due on the gain, unless or until the policyholder withdraws the funds.
Universal life insurance vs whole life
While both universal life and whole life are types of permanent life insurance, universal life is considered to be more flexible than whole life coverage.
One reason for this is because a universal life insurance policyholder is allowed to change, within limits, their death benefit as well as the timing and the amount of their premium payments unlike whole life.
Each time that a premium payment is made, the insurance company will deduct a certain amount to cover the cost of the insurance while at the same time crediting another portion of the payment to the policy’s cash value account.
In fact, the policyholder is actually able to move funds between the cash value and the death benefit components of the universal life plan – and since the premiums are flexible, the policyholder can adjust the proportions of the policy based on external market conditions.
How does the cash value grow in a policy?
The cash value of a universal life insurance policy is guaranteed to grow at a minimum rate of interest. However, these funds may actually grow more, depending on market performance. Depending on the type of UL policy, there may be other methods of growing the cash value.
With an indexed universal life insurance policy, the return on the cash value is determined in large part by the performance of an underlying market index, such as the S&P 500. For example, if the index performs well during a given year, then the cash value is credited with a positive return, typically up to a set maximum, or “cap.”
If, however, the underlying market index performs poorly during a given year, then the cash value will not incur a negative return, but rather will be credited with just a 0% for that time period. So, although there is not a positive return credited at that time, the principal in the policy is still protected, regardless of what happens in the market.
Universal life policies will also have a fixed crediting option. Here, the growth of the cash value is based upon a rate that is set by the insurance carrier.
Cost of universal life insurance
There are several different factors that will determine the premium cost of a policy. These include the following:
- Tobacco Use
- Product Type
- Coverage Amount
- Health History
- Family History
- Financial History
- Criminal History
- Medication History
- Insurance Company
- Length of coverage (for term life insurance)
The different types of policies?
There are different types of universal life insurance policies available in the market today. These include guaranteed universal life (GUL) and indexed universal life (IUL).
Guaranteed universal life insurance, or GUL, is somewhat of a “hybrid” life insurance option that offers permanent death benefit protection like whole life insurance, but often with more affordable premiums like term life policies. A GUL policy will oftentimes have level premium rates until the insured’s age 100, or even later.
Indexed universal life insurance has its cash value performance tied to the return of an underlying market index. However, these policies also offer a guarantee that the value of the cash account will not fall below zero if the index encounters a negative performance at any given time. Likewise, an IUL policy will also typically have a “cap” on the amount of positive growth that can occur. This means that, even if the underlying market index performs very well, the return on the cash value will not rise above the set cap.
IUL Vs. GUL
With an IUL policy, the return on the cash value is based in large part on the performance of an underlying market index, and because of that, the cash value in an IUL policy may grow as a GUL will have no cash value accumulation.
Disadvantages of universal life insurance
Although there are many benefits of owning a guaranteed universal life insurance policy, there are some options that these types of plans will not provide, such as:
- Unlimited growth / return
- The affordability of term life insurance
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