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MRDT Member

by: Zeus Design


Universal Life Insurance

What is Universal Life Insurance?

Universal life insurance (UL) is a combination of term insurance and whole life insurance that provides affordable death protection with considerable policy flexibility.

With universal life, the costs of insurance are based on annual renewable term insurance rates that increase annually as the age of the insured increases. Additionally, universal life offers a cash value account that grows tax-deferred at a current interest rate much like whole life insurance. Universal life essentially combines the advantages of low cost term insurance with a tax deferred savings vehicle. This unique policy design allows for adjustable policy premiums and insurance face amounts making the UL policy a versatile tool that is adaptable to changing situations and circumstances.

Universal life is known for its flexible premium payment options. Because universal life insurance policy costs are based on annually renewable term insurance, they can be separated and identified. Knowing the actual policy costs, the policy owner has the option of paying the minimum premium that is required to cover these basic costs or to pay a higher premium and take advantage of the tax deferred account to accumulate cash values. The choice is with the policy owner as to how a UL policy is funded.

In fact, premiums may be paid on a non-scheduled basis or even skipped. As long the minimum required premium is made or the policy has enough cash value to cover the current policy costs, the coverage will remain in force. However, premium payments and policy costs should be closely monitored to assure that over the long term that the policy’s cash values increase to offset insurance cost increases in the future. As discussed, annual renewable term insurance increases in price annually as the insured gets older. These cost increases must be paid out of current policy premiums or the policy’s existing cash values. If the premium is not sufficient to cover policy costs, the cash value account makes up the difference. Once the cash value account reaches zero, either premiums must be increased substantially to cover the increasing insurance costs or the policy lapses with no value. For more details see, “How a Universal Life insurance Policy Works”.

Universal life insurance offers two death benefit options. With death benefit Option A, commonly referred to as the “level death benefit option”, the insurance face amount remains the same regardless of cash value growth as long as changes are not made to the policy. With death benefit Option B, or the “increasing death benefit option”, the insurance death benefit is determined by adding the current policy cash value to the initial policy face amount. Option A is commonly used in situations where cash value accumulation is the main policy objective. Option B, used more infrequently, is best for when greater amounts of insurance are required.

With universal life, the policy face amount may be raised or lowered depending on the specific policy and subject to contract minimums. In all cases, when coverage is increased, the insurance company will require proof of good health. Additionally, when coverage is decreased, some companies may require a surrender charge to be paid. Either way, having the option to increase or decrease the insurance coverage amount provides significant flexibility to the policy owner.

For example, let’s say you currently own a UL policy with a face amount of $1,000,000. The policy was initially bought when your three children were still in school and had a sizeable mortgage balance. Since then, all of your children have graduated college and you no longer have a mortgage. The initial $1,000,000 of universal life insurance is no longer required, but some coverage still needs to be maintained. In this case, you can reduce the policy’s face amount to a level that meets your current needs without any hassle. Additionally, you now have the option to change your premium payment strategy and increase premiums to grow cash values.

Universal life policies have contractually guaranteed minimum interest rates of between 2-4% annually. The interest rate is credited annually to the policy’s cash value account which grows tax deferred. Currently, most UL policies pay a higher current interest rate that is based on the prevailing economic conditions. Over time, the actual interest rate credited to the policy’s cash value will vary somewhat significantly. Because, universal life policies are flexible and are subject to several variables, the policyholder should always pay special attention to the growth of the cash value as it relates to the projected growth and projected premium payments. A careful review of your policy’s annual in force illustration will provide valuable insight on the long term performance of your policy. For more information see, “What is an Inforce Illustration?”

Universal life insurance is a valuable life insurance tool because it offers low cost life insurance protection with the ability to grow cash values that are tax deferred. The flexibility of universal life is what makes UL policies so unique. Over time, the ability to customize a policy to meet your changing needs makes universal life and excellent policy choice.

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