Learn About Universal Life Insurance
Universal life insurance (UL), also known as flexible premium or adjustable life, is one of the three types of permanent coverage. Often described as permanent term insurance, universal life offers the initial low cost of term insurance, but with the opportunity to build cash value over time.
Like term insurance, the price per $1,000 of insurance increases with the insured’s age; universal life is considered to resemble an annually increasing term. During the policy’s earlier years, a greater percentage of the ongoing premium is deposited into the cash account. As the cost of insurance increases annually, during the policy’s later years, a smaller portion of the ongoing premium is deposited into the cash accumulation account. In most policy instances, little to no cash remains within the policy at death, as it was used to supplement the cost of insurance. As such, the premiums for this type of permanent coverage are the most expensive among the cash value insurance offered.
Common Uses for a Universal Policy
People purchase life insurance to either protect someone they love, or to pay someone they owe. However, a number of variations to these basic purposes exist. Individuals and families utilize universal life for a variety of purposes including:
- Covering final expenses- The average burial costs today range from $10,000- 15,000.
- Income replacement for a surviving spouse or child
- To cover estate tax costs
- Business succession planning- i.e. buy-sell agreement funding
- Key man insurance for small businesses
- Funding for executive bonus plans under the IRS code 162
- Business split dollar plans
- Non-qualified deferred compensation program for employees
- Charitable gifting funding
- Alternative to term insurance programs
- Pension bridge- Some employers will offer a lower annuity/pension payment to employees who select reduced survivor benefits. In the event the former employee dies prematurely, their surviving beneficiaries will receive a reduced pension amount. However, this pension option often pays a higher benefit today. In order to capitalize on the higher benefit option today, the employee may select to purchase a universal life insurance policy to bridge the pension gap amount. This option allows for both the employee to take more income today and the financial protection of their beneficiaries.
Universal Life’s Flexibility
One of the most attractive qualities of a universal life insurance policy is its flexibility. Unlike the UL’s cousin, whole life insurance, the premiums, death benefit and cash value of the policy can be adjusted to meet changing needs over time. Premiums can be adjusted up or down to meet the policy holder’s current cash flow. It is recommended that the policy holder pay at least the recommended annual minimum, to ensure that the policy isn’t at risk for lapse. The ongoing premium can be increased to the policy’s maximum, as stated in the original documents.
In addition to the ability to modify the premium amounts, the manner in which premiums are paid is also flexible. Premiums can be made on a single payment basis, or an ongoing basis.
The single premium allowable will be determined by the policy’s stated amount and should fall below the Modified Endowment Contract (MEC) amount. When a contract becomes a MEC, it has exceeded the IRS code, removing much of the tax benefits to be discussed shortly. In order to fund the policy with a single premium, without causing the policy to MEC, the correct amount needs to be deposited; no more, no less. It is recommended that you work with a financial professional to determine these figures prior to making your deposit.
Ongoing premiums can be made on a monthly, quarterly, semi-annually or annual basis as desired, up to the annual policy limit.
Universal Features & Benefits
The features offered on a universal life policy will vary based upon the underlying insurance company. However, some of the basic features you will likely see across most policies will include:
- Interest Rate Offered for Cash Accumulated- The interest rate offered on the policy’s cash value is typically determined by current interest rates. In many cases, the underlying insurance company will offer an interest rate guarantee, or the lowest rate the insured can expect on their cash value. In some cases, the interest paid within a universal life insurance policy is linked to a market index.
- No Lapse Guarantee- It is important to note than unlike whole life insurance where the death benefit is guaranteed, universal life insurance policies shift some of the inherent risk to the policy holder. In the event that the insured stops making premium payments, and there isn’t sufficient cash value to pay the ongoing premiums, the policy will lapse. In an effort to make these policies more attractive despite of this possibility, some insurance companies have developed a ‘no-lapse guarantee’ option as a policy rider. This rider states that if minimum payments are made over a specified period of time, the death benefit will be considered guaranteed, even if the policy’s cash value drops to zero.
- Tax Benefits- Cash that accumulates within the policy is treated on a tax deferred basis. Should the cash be withdrawn by the policy holder while the policy is in-force, it may not be subject to federal income taxes, rendering it a ‘tax free’ withdrawal. To capitalize on this benefit, the policy must remain in force until age 100, or until the insured’s death, and the withdrawals are actually taken as policy loans, rather than as cash surrenders.
- Death Benefit- In most cases, the death benefit is received by the stated beneficiaries without federal income taxation. The possible taxation is derived from estate taxes, not income taxes, and this possibility will be determined both by the insured’s total estate value and the estate tax laws at the time of death.
- Cash Value Withdrawal Potential- Should the universal life policy accumulate cash value, the insured has access to this cash under the policy’s provisions. When taken as a policy loan, which is the preferred method in most cases for a withdrawal, the amount is not subject to federal income taxation.
- Disability Waiver of Premium- Some insurance companies will offer this additional rider, designed to protect the underlying insured against a possible disability. When a disability occurs, one of the first things people cancel in an effort to reduce their overhead is what they believe to be extra insurance. Unfortunately, life insurance shouldn’t be considered ‘extra’ and should certainly not be cancelled in the event of a disability. This rider will pay the insured’s insurance premiums in the event that the disability extends past the stated waiting period, normally 90-180 days. This payment option will enable the insured party to retain their insurance benefits in the event of a disability.
- Convertibility- Most insurance companies will permit an insured party to convert their insurance to one of the other two permanent types without evidence of insurability, as long as their death benefit either remains the same or is reduced.
How Much Coverage do you Need?
This is an age old question. While some financial professionals may offer a rule of thumb, such as 5x or 10x your annual income/salary, trained professionals will state that the answer to your question isn’t that simple.
To determine how much life insurance you need, it is important to first evaluate the purpose of the coverage. What is driving you to consider life insurance? Are you looking to cover burial costs, make a charitable donation, cover potential estate taxes, provide for a survivor’s ongoing income needs or pay down/off debts owed? The amount required to meet your financial needs will be dependent upon what you are trying to accomplish with the purchase of life insurance.
For example, if your goal is to cover future estate taxes, your estate planning attorney will often advise you as to the estimated amount you should consider obtaining. If your goal is to cover a surviving spouse’s income needs, your first assessment should be how much your annual household requires to maintain the current lifestyle. Whatever this annual figure is will in part, determine how much life insurance face value is required to produce it.
Most financial experts suggest that an interest rate between 4-5% is realistic for income production, as most people in this stage are more conservative with their investment choices; less focused on capital accumulation. Using this figure, the amount of insurance face value needed should yield the income your household requires assuming the cash balance yields between 4-5% annually. For example, if your current household’s expenses are $75,000 per year, you would need a cash amount equal to $1,500,000 to yield the income needed on an annual basis.
Comparing Insurance Company Offers
If you believe that a universal life policy is the best for your specific financial goals and needs, it is time to request quotes for comparison. When comparing quotes, it is important to ensure that you are comparing apples to apples, as many variations can exist between insurance companies.
The first thing to review with each quote is the assumed rating class. Your rating class is something that represents your overall state of health, and at the time of underwriting, isn’t a firm offer, but rather a quote to be sent to underwriters for review. Most insurance companies work with a sliding rating scale, but how they classify each rating will be slightly different. For example, one company’s top tier may be elite, while another’s may be preferred plus.
Be sure to inquire into how the rating you are being quoted actually fits on their overall scale, and how they determined that this would be the best option to start with. Most insurance agents will choose a standard rating over a top tier rating, to avoid telling you that you have either been declined or that your rating has decreased, as this will require additional premium for policy delivery.
In addition to reviewing the ratings quoted, review the policy’s guaranteed interest rate, the range paid over the past few years, the company’s default rates, the company’s financial ratings and the last time or frequency of policy rate increases.
The flexible nature of a universal life insurance policy makes them attractive options for both business and personal purposes. As with any insurance policy, it is recommended that you spend time evaluating your specific needs and budget prior to selecting a face amount, and that the policy you choose fits within your overall financial objectives.