UNIVERSAL LIFE INSURANCE
What is Universal Life Insurance ?
People who wish to provide health security for themselves and at the same time give a financial safety net to their loved ones even after their passing are the key elements when deciding on life insurance. There is a wide array of life insurances to choose from. Therefore, it is essential for a potential policyholder to carefully and meticulously choose which life insurance would suit their requirements and, most importantly, be afforable.
Universal Life Insurance Defined
Universal life insurance (UL) or adjustable life insurance is a mix of a life insurance policy that merges elements of term life insurance with an investment savings option. Universal life offers lifelong coverage, provides flexibility to reduce or increase their death benefit, and pay premiums at any time in any amount- though subject to certain limits- after making their first premium payment. This gives an advantage by allowing flexibility in what a policyholder can do with the savings or investment portion of the premium.
Variations such as variable and indexed universal life insurance gives the policyholder the opportunity to choose how to invest the policy’s cash value. Universal life insurance is frequently compared to whole life insurance, a policy that also offers lifelong coverage, but is cheaper and offers more policy options.
Universal life insurance policyholders have the opportunity to increase the face value of their insurance coverage. However, to qualify for this benefit, a medical examination must be passed first. Likewise, a policyholder may choose to decrease their coverage to a minimum amount without forfeiting their policy. It is important to note that surrender charges may be applied against the cash value of the policy.
Two Kinds of Universal Life Insurance
- Traditional Universal Life Insurance (UL)
- Indexed Universal Life Insurance
Instabilities in the stock markets can make traditional UL too risky. Therefore, discussing the effects an investment will have in the event of a stock market downturn is an important undertaking.
Universal Life Insurance: How it Works
Unlike term life insurance that only provides coverage for a set period of time, universal life insurance is permanent insurance, which means coverage can last on a policyholder’s lifetime as long as premiums are paid.
A chunk of universal life insurance monthly premium is put into the cost of the life policy that will provide the death benefit to their beneficiary and another chunk is invested so it can be used as investment savings. The idea is that the investment will increase over time and may eventually be able to pay for the premiums of the life portion of the policy. The benefit is that the policyholder could pay into a specific number of years, and the investment would eventually start to cover the cost of the premium, then end up getting life insurance for life without the need to keep on paying. Universal life insurance may be availed by individuals but is also offered by employers as group universal life insurance.
Indexed Universal Life Insurance: How it Works
Indexed universal life insurance has many similarities with the standard universal life insurance policy; one difference is that the cash value’s growth is tied to the performance of an index. Every insurance provider has their personal selection of indices available. Depending on the policy, a policyholder may choose more than one. Some indices most commonly offered are the S&P 500, NASDAQ 100, and Russell 2000. Performance is normally measured, excluding dividends.
Investing the cash value in a fixed interest rate account and an account tied to the performance of an index can be done with indexed universal life insurance. The insurance provider will track the performance of the cash value of each investment once a policyholder gives the percentage of cash value that must go into each investment.
If a policy’s cash value growth is bounded to the performance of an index, there are some constraints that a policyholder should take note:
- Maximum Guaranteed Annual Interest Rate – might be 0% or higher, depending on the insurance provider.
- Maximum Annual Interest Rate – rate of return is bounded to the performance of the index; however, the policyholder is not actually invested in the index. Which is why the insurance provider limits the maximum interest rate they will pay at around 10-12%.
- Participation Rate – the percent of money credited if invested in the index. Therefore, if there is a $10,000 cash value tracking the S&P 500 and the index had a 10% return annually, it could be assumed that the cash value increased by $1,000. However, that assumes a 100% participation rate. If the insurance provider’s participation rate was 5%, the policyholder’s cash value would grow by $500, or just a 5% return ($10,000 x 50% x 10% = $500).
Cash Value and Premium Payments
Universal life insurance has a cash value element that is different from the death benefit. Every time a premium payment is made, a chunk is placed to the cost of insurance like administrative fees and covering of death benefit while the rest becomes part of the cash value. The cash value is guaranteed to increase according to a minimum annual interest rate, but might increase faster depending on the policyholder’s insurance provider’s market performance.
A universal life insurance policy’s cash value may be used as the following:
- Surrender Value. If the policyholder decides they no longer want the policy, they can return it to the insurance provider (“surrender” it), and the insurer would give the cash value in return.
- Loan Collateral. The policyholder may borrow the money from the insurance provider and use the cash value as collateral, which meant it is the maximum amount that can be borrowed. These policy loans are subject to interest rates set by the insurance provider.
- Premium Payments. The cash value may be used by the policyholder to pay a portion of the entire premium payment. Take note that policies will lapse if the cash value drops to zero. Therefore, keeping a close track of the amount is necessary.
Since universal life insurance policy premiums are divided between the cost of coverage and cash value, there is a choice of how much a policyholder pays as long as it falls between the minimum and maximum premium amounts. Many policyholders choose to pay the maximum premium possible for the first several years of the coverage to build a high cash value. Then, use the accumulated cash value to pay premiums later. This is a good plan if a policyholder plans to maintain permanent coverage even when they have smaller income during retirement. The drawback is if the cash value runs out, the policyholder can get stuck paying the entire cost of insurance, and there will be no surrender value to the policy. The policy can also lapse if the cash value reaches zero.
If a premium’s cash value runs out, it could cause the insurance cost to increase. Insurance cost can be level for the life of the policy though unusual. Normally, there is a minimum and maximum cost of insurance, so, as the policyholder ages, the minimum premium also increases considerably. If a fixed-income policyholder’s cash value diminishes, they may be in a bad situation, and their policy will lapse, which would cause a loss in coverage. It is for this reason that keeping close track of their policy’s cash value is of the utmost importance when they opt to use it to pay premiums.
When deciding which coverage to determine, take a good note of the difference between the guaranteed performance of a policy and the projected performance. The guaranteed performance reveals the worst-case scenario of minimum returns and maximum fees that can be charged by the insurance provider.
Maturity Date
The maturity date of universal life policy occurs when the policyholder turns to a specific age – usually around 85 and up. Once it reaches the maturity age, the policyholder generally receives a payment and coverage ends. Depending on the chosen policy, the payment could be the death benefit or a specific value.
Living after the insurance’s maturity date and using most of the cash value to pay premiums may pose a problem as it can result to little money returned without coverage. Hence, choosing a policy with a good maturity date based on the intended use of the coverage is wise. So, if the policyholder does not want their family to pay inheritance taxes once they pass, a very high age for the maturity date must be chosen.
Universal Life Insurance Options: Indexed Universal Life Insurance (IUL)
Universal life insurance success is heavily dependent on the investments in the chosen plan and market performance. For years, concerns with the values in the investment element of universal life insurance is prevalent due to unstable markets. This led to the evolution of indexed universal life insurance (IUL) to address concerns with changing markets and other problems that surfaced in the past. IUL may seem to give more safety than UL for those who are thinking to purchase universal life insurance. Asking a financial planner before choosing an option is a great step to see how they fit one’s needs and long-term investment strategy.
The Best Time to Buy Universal Life Insurance
Deciding to buy universal life insurance while in the 20s or 30s will give the greatest chance to build one’s assets.
The idea of a universal life insurance policy is to have it for at least 10-15 years before starting to cash out or change investments. If a universal life insurance policy is purchased in your 20s, you could be assured to have a policy your entire lifetime by the time you settle down and have kids. The asset portion may be used as a down payment when they decide to purchase a new home. Although this largely depends on the kind of universal life insurance chosen and its market performance. Remember that purchasing life insurance while younger gives benefit despite the lower rates. Therefore, remember that even if life insurance looks expensive at present, it will become pricier later on. An individual’s overall life strategy must begin once they decide on life insurance.