Universal Life Insurance Explanation

This is part five in a series of articles explaining the various types of life insurance products. To start at the beginning please click here.

Universal life insurance was created back in the 1980s to take advantage of the preferred tax treatment that life insurance policies receive from the IRS. As with whole life insurance, the life insurance company will offer death benefit coverage for the rest of your life. Unlike whole life insurance, the premiums are not guaranteed to be level.

The easiest way that I can think of to describe universal life insurance is that you are basically setting up a savings account to pay your life insurance premiums. A premium is paid to the life insurance company. The company then takes out any administrative fees and deducts the cost of the life insurance (COI) and the rest of the premium is credited to an account. The balance in your account is then credited an interest rate by the insurance company. There is usually a minimum guaranteed rate for the policy, but the actual rate credited usually fluctuates above that amount based on how well the insurance company’s investments are doing. As long as there is a cash value balance above zero the life insurance policy does not terminate. This makes universal life insurance more flexible than term or whole life insurance. A universal life insurance policyholder can usually make premium payments whenever and for whatever amount they choose as long as the balance stays above zero.

One benefit to a universal life insurance policy is that the balance or cash value in the policy earns interest tax free, unlike other investment vehicles like money market accounts or certificates of deposit. Despite this tax favorable tax treatment, it is usually not a good idea to buy universal life insurance just for the tax-free investment since you also have to pay for life insurance. There are some legitimate estate planning reasons to buy universal life insurance, but it is usually not the best option for someone either needing only life insurance protection or only an investment vehicle.