Universal life insurance is a popular form of permanent life insurance, but is it right for you? Like any financial tool, it depends on how you want to use it. What are your financial goals? What is your tolerance for risk? How much control do you want to have over your future wealth?
For many people who purchase a universal life insurance policy, the idea of cash value—a built-in savings/investment account within the policy—and its flexible payment options are appealing. But the truth is, most permanent life insurance policies render a cash value. And when it comes to infinite banking—using the cash value of your policy as your own private bank—and retirement planning, universal life insurance often isn’t the best option.
In this article, we’ll explain the 3 types of universal life insurance and the difference between universal life insurance and whole life insurance to help you decide which is best for you and your family.
TYPES OF UNIVERSAL LIFE INSURANCE
Universal life insurance policies fall into 3 categories: guaranteed, indexed and variable.
Guaranteed Universal Life Insurance is the least expensive universal policy. It functions more like term life insurance that doesn’t expire. The majority of guaranteed universal life policies earn little to no cash value.
Indexed Universal Life Insurance earns cash value based on the performance of certain market-based indexes, determined by your insurance provider. Common indexes include the S&P 500 or NASDAQ. Indexed universal life policies are more expensive than guaranteed universal policies because they earn cash value. However, they tend to be less expensive than variable universal policies and whole life policies.
Variable Universal Life Insurance earns cash value based on the performance of a portfolio of stocks and/or bonds, similar to mutual funds. These may be determined by your insurance provider or a broker, or you may have the option to choose your own. Variable universal life insurance tends to be the most expensive type of universal life insurance because policies usually charge brokerage fees for managing investments.
3 IMPORTANT QUESTIONS TO ASK BEFORE YOU PURCHASE UNIVERSAL LIFE INSURANCE
- If the insurance company raises my premium, will I be able to afford it?
- How would I feel if my cash value declines or reduces to zero?
- Am I okay with knowing that my death benefit may also decline or expire?
After evaluating your responses, you might be asking yourself why anyone would purchase a universal life insurance policy.
One of the appealing features of a universal life insurance policy is that the owner has flexibility when it comes to premium payments. If you have a financial hardship or unexpected expense, it’s possible to pay less on some premiums or use your cash value to cover policy costs. But there are two sides to every coin—your insurance company may choose to raise premiums at their discretion, meaning there is a very real possibility your policy will become more expensive over time.
Whole life insurance, on the other hand, has level premiums. They remain constant for the duration of the policy. It’s easy to budget with whole life insurance because you know the cost of the policy won’t change. And unlike universal life insurance, it’s possible to structure your whole life policy to be paid-up by a certain age, like retirement, so you don’t have to continue paying premiums.
If your universal life insurance policy is an indexed or variable one, the cash value of the policy is tied to market-based equity funds, which fluctuate in value. If market performance is up, you may earn significant gains in a given period. If the market experiences a downturn, you could earn nothing—or even lose cash value. This can be detrimental, particularly if you were counting on the cash value of your policy to help pay premiums, fund other investments, or to provide supplemental retirement income.
What’s more, indexed and variable universal life policies may place a cap on market gains or set a participation rate, which limits your upside potential. Depending on your insurance company, indexes and mutual funds may also set a predetermined performance threshold that must be met before you can tap into gains.
Whole life insurance policies have a guaranteed rate of return not tied to market-based funds. Your policy illustration outlines exactly how much your cash value will grow in a given period, and it won’t lose value—even in the event of a market downturn. What’s more, whole life policies purchased through mutual insurance companies also earn non-guaranteed dividends. (The top-rated mutual insurance companies we work with at Paradigm Life have historically paid out dividends for over 100 years.) These dividends can further increase your cash value, be used to buy supplemental insurance like paid-up additions, and help cover policy premiums. They can also be cashed out and are typically tax-free.
Because a policy’s cash value is indicative of its death benefit, a universal life insurance policy that risks losing cash value may also have a death benefit that declines or even expires, rendering the policy void. If you need life insurance that is guaranteed not to lapse, universal life insurance may not be the best option.
Whole life insurance works differently, in that it isn’t exposed to the same market risks that can affect cash value. It offers more guarantees, including a no-lapse guarantee, provided premiums are paid.
UNIVERSAL LIFE INSURANCE POLICY RIDERS
When you buy an insurance policy, you often have the option to add policy riders—additional coverage for targeted needs. Policy riders allow you to customize your policy to fit your unique financial needs and goals. Most universal life insurance can be customized with the following riders:
- No-lapse guarantee: Your policy is guaranteed not to lapse if your cash value falls below a certain threshold.
- Guaranteed insurability: You may increase your death benefit at certain periods over the lifetime of the policy without additional medical exams.
- Disability/waiver-of-premium rider: Policy premiums are waived if you become medically disabled
- Accelerated death benefit rider: Access your death benefit while you’re still living if you are diagnosed with certain terminal/chronic illnesses.
- Accidental death benefit rider: If you die accidentally, the death benefit paid out to your beneficiaries increases.
- Child/spouse riders: Add supplemental insurance coverage for your spouse and/or children.
If your primary goal is to increase tax-advantaged wealth, however, you may want to opt for a whole life insurance policy. It’s the only permanent insurance policy that can be customized with a paid-up additions rider. Paid-up additions allow you to “overfund” your insurance policy to supercharge it for growth. By maximizing payments in the early years of the policy, you exponentially increase returns and generate greater cash value over the lifetime of the policy.
GETTING MORE OUT OF YOUR LIFE INSURANCE POLICY
Just like any other financial product available to put your money into, each has a specific purpose. Not all universal life insurance policies are bad, but it’s rare that people get what they expect from them. The best safeguard against hidden traps within an insurance policy is to understand the guarantees the policy can offer. The guarantees are the foundation to building a successful infinite banking strategy and solid retirement plan. A whole life insurance policy is the only permanent insurance vehicle that can:
- Guarantee a fixed premium
- Guarantee cash value principle and growth
- Secure a death benefit for the rest of your life
What’s more, with the right whole life policy you can borrow your cash value and still earn guaranteed returns on it, in spite of outstanding policy loans. Essentially, you can borrow a dollar and invest it at the same time.
If you already have a universal life insurance policy that is underperforming, you may be able to salvage the tax-advantaged cash value via a 1035 Exchange, which allows you to essentially “roll over” your cash value into another insurance product, like a whole life insurance policy.
Case study: What to Do When Universal Life Insurance Fails
FREE FINANCIAL EDUCATION WITH PARADIGM LIFE
Ready to see what a personalized life insurance policy could look like for your budget and financial goals? The expert Wealth Strategists at Paradigm Life work with the nation’s top-rated mutual insurance companies to find the best policy for you and your family. Consultations are always free, and we offer complimentary continuing financial education to equip you with the knowledge you need to take control of your financial future.
From online video courses, to our comprehensive blog articles, Perpetual Wealth Strategy podcast and free annual policy reviews, all the tools and expertise you need are at your fingertips.