What is Universal Life Insurance?
Universal life insurance is the least expensive permanent product.
How Does Universal Life Insurance Work?
It is similar to a whole life insurance policy whereas it is designed to be permanent but with three major differences.
- Lower cost
- Flexible premiums
- How it’s funded
The initial cost for a universal life product will generally be less expensive than a whole life policy unless you are over the age of 65.
Over age 65 universal life can sometimes be a higher cost than a whole life policy.
Universal life insurance policies have flexible premiums.
Meaning there is a planned premium, a target, and a maximum.
Generally, as long as your planned premium is at the target your policy will be permanent for life.
The benefit here is that when times get tough or you need to make changes you can.
Whereas with whole life you can’t.
The second important difference is how the policy is funded.
How It’s Funded
With a universal life insurance policy, it can be funded three different ways.
- Current interest rates
- Interest crediting
- Mutual funds
Current Interest Rates
Traditional universal life insurance is funded with current interest rates.
The traditional universal life policy was created in the late 1970s when interest rates were in the double digits.
You could get over 10% interest in a savings account.
And the whole life average of 5% dividends was not as attractive.
People were cashing out their whole life policies to put money in a savings account!
So universal life was created to grow the cash value based on current interest rates.
Today, the most popular universal life insurance policy is the index universal life policy, or IUL.
The IUL is funded with interest crediting.
Basically, your cash value can receive the upswing of the S&P 500 index stock market with a cap but with no downside risk.
See, within most IUL policies, your plan will receive a guaranteed interest rate to cover some of the insurance fees.
Then during the interest sweeping periods, you will receive an interest credit based on how well the S&P 500 index performed.
Here is an example:
Let’s say the S&P 500 returned 8% in that period.
Your cash value would receive an 8% interest credit.
Now, if that same period returned a 20% return, most policies have a cap of around 12%.
Meaning you would receive a cap of 12% crediting rate even if that period returned over 12%.
Still not bad, right?
Now for the best part.
If the S&P 500 returned a -10% or -5% your account’s cash value would stay the same and NOT go down like the market.
It would simply not receive any interest crediting in that period.
Amazing I know!
Generally, this is how all IUL policies work to a certain extent. Each plan is different with different caps, guaranteed interest rates, and fees.
Now, I’m not going to discuss variable universal life as we do not recommend that product to our clients.
Variable universal life is funded with mutual funds and you can read more about it here.
As for some of the similarities with whole life, the cash value generally works the same way.
Based on the IRS code, the cash value inside of a whole life and a universal insurance policy can grow on a tax-deferred basis.
Meaning that each year the cash value grows you would NOT have to pay income tax on the growth.
This major benefit is a highlight for most people purchasing a universal life insurance policy.
An additional benefit is the income tax-free access through policy loans.
Income Tax-Free Access
You can access your universal life cash value through policy loans.
See, with this strategy you are NOT actually accessing your cash value inside of the policy.
If you were the insurance company would have to send you a 1099 and then you would have to pay income tax.
Instead the insurance company “loans” you the cash value from their account using your policy as collateral.
However, the insurance company does charge you an interest rate. With most universal life policies the rates are variable but are generally around 4% to 5%.
You do not have to pay the interest today out of your pocket.
Generally, the insurance company will collect the interest when you pass away.
See the idea is that the insurance company will loan you the cash value, charge you interest, and then deduct the loan plus any interest from the death benefit.
This is a great workaround to accumulating and accessing your cash value on a tax-efficient basis.
So to wrap up, I know this might be confusing but please don’t worry.
We are here for you and can answer any questions you might have.
We can also help you search the market for the best universal life options and compare them to other products for the best value.
For an in-depth review of your current policies or if you have additional questions about whole life Insurance please click here for a FREE insurance review.
Universal Life Highlights
- Designed to be permanent coverage for life
- Flexible premiums
- Specific premium payment period
- Lowest cost permanent product
- Tax-deferred cash value growth
- Access cash surrender value on an income tax-free basis through policy loans
National Life Group LSW is the most popular universal life insurance company chosen by our clients. Their built-in living benefits and competitive rates separate them from the pack. They provide industry-leading service, pay claims fast, and have an expedited application and underwriting process to get clients approved quickly.
These are just some of the reasons why National Life Group LSW is our most popular universal life insurance company chosen. To compare your policy to National Life or the market for the best value please click here to schedule a FREE insurance review.