Resources · Life Insurance
Understanding Universal Life Insurance: How It Works and What to Expect
Universal life insurance combines a death benefit with a cash value component that earns interest. This guide explains how the policy works, what affects your costs, and the key terms you'll encounter when evaluating thi
Nate Corrieri
Licensed insurance producer · 3 min read
What Universal Life Insurance Is
Universal life is permanent life insurance with flexible premiums and an adjustable death benefit. Unlike whole life, where premiums and benefits stay fixed, universal life lets you increase or decrease your premium payments within limits. Part of each premium goes toward the cost of insurance (the mortality charge), part covers administrative fees, and the rest goes into a cash value account that earns interest. The policy stays in force as long as there's enough cash value to cover the monthly charges.
How the Cash Value Component Works
The cash value in a universal life policy earns interest based on rates the insurer sets, which can change over time. The insurer typically guarantees a minimum interest rate, often around 2% to 3%, but actual credited rates may be higher depending on market conditions. You can access this cash value through withdrawals or loans, but taking money out reduces the death benefit and can cause the policy to lapse if the cash value drops too low to cover ongoing charges. Growth in the cash value is tax-deferred, meaning you don't pay taxes on gains as long as the money stays in the policy.
Premium Flexibility and What It Means
You can pay more or less than the planned premium in most universal life policies, as long as you cover the minimum required to keep the policy active. Paying more builds cash value faster; paying less draws down the account. If your cash value runs out and you stop paying premiums, the policy lapses. This flexibility can help if your income changes, but it also means you need to monitor the policy to make sure it doesn't accidentally run out of money. Insurers provide annual statements showing your current cash value and projected performance.
Cost of Insurance and How It Changes
The cost of insurance inside a universal life policy increases as you age, because the risk of death goes up. Early in the policy, these charges are low. Later, they can become significant and eat into your cash value if you're not adding enough premium to keep pace. Some universal life policies use level cost structures for a period of years, but most increase over time. Understanding how these charges grow is important when deciding how much premium to pay and whether the policy will perform the way you expect in the long term.
When Universal Life Makes Sense
Universal life can work well if you want permanent coverage with some control over how much you pay each year. It's often used for estate planning, to cover business obligations, or as a long-term financial tool for people who want the option to adjust their strategy. The tradeoff is that the policy requires more attention than term or whole life. You'll need to review it periodically to make sure the cash value is on track. If you prefer a set-it-and-forget-it approach, other types of life insurance may be a better fit.
Glossary
Key terms to know
- Cash Value
- The savings component inside a universal life policy that earns interest and can be accessed through loans or withdrawals.
- Cost of Insurance
- The monthly charge deducted from your cash value to cover the mortality risk and keep the death benefit in force.
- Credited Interest Rate
- The rate of interest the insurer applies to your cash value, which can vary but is usually guaranteed to stay above a minimum floor.
- Death Benefit
- The amount paid to your beneficiaries when you die, which can be adjusted in many universal life policies.
- Policy Lapse
- What happens when your cash value runs out and you stop paying premiums, causing the policy to terminate without value.
- Surrender Charge
- A fee the insurer may charge if you cancel the policy or take a large withdrawal in the early years.
- Flexible Premium
- The feature that lets you vary how much you pay into the policy each period, within certain limits set by the insurer.
- Minimum Premium
- The least amount you must pay to keep the policy from lapsing, based on current cash value and cost of insurance charges.
General information only, not legal, tax, or financial advice. Coverage details, availability, and features vary by carrier, product, and state.
More on Life Insurance