Universal life insurance is a kind of cash value life insurance. Under the terms of the life insurance policy, the excess of premium payments that is above the current cost of life insurance is credited to the cash value of the life insurance policy. The cash value is then credited every month with interest, and the policy is debited each month by a cost of insurance charge – also known as a COI. At this point, any other life insurance policy charges and fees are drawn from the cash value. This would take place even if no there premium payment made that month. Interest credited to the account is determined by the insurer but has a contractual minimum rate, which often sits at around 2%.
What is an Indexed Universal Life Contract?
A universal life insurance policy is considered an indexed universal life policy when an earnings rate on its cash value is pegged to a financial index. This means that it is pegged to something like a bond or a stock. These kinds of life insurance policies offer the advantage of guaranteed level premiums throughout the insured’s lifetime. Not only that, but these premiums are generally provided at a significantly lower cost than an equivalent whole life policy initially is. The policyholder will be able to view the cost index table – which is often one of the first four pages of a life insurance contract. This table will provide the policyholder with insight as to how much the cost of insurance increases over time. This can be an excellent resource for policyholders as it allows for easy comparison of the expenses between carriers.
What are Some Uses of Universal Life Insurance?
- A form of income replacement – to provide for surviving spouses and dependent children once one parent has passed.
- Final expenses – These include unpaid medical bills, visitations, funeral, and burial.
- Debt coverage – to pay off personal and business debts. This can include anything like a credit card, home mortgage, a personal line of credit or a business loan
- Estate liquidity – This means that the estate in question has an immediate need for cash to settle federal estate taxes, state inheritance taxes, or unpaid income taxes on income in respect of a decedent.
- Estate replacement – when a policyholder has decided to donate their assets to a charity and hoped to replace the value with cash death benefits.
- Creditor/predator protection – If the policyholder is someone who earns a high income, or who has a high net worth, and who is in a profession often suffers a high risk from predation by litigation, they might benefit from using a universal life insurance policy as a way to stash money. This is because in some states the policies are under protection from the claims of creditors, including judgments from frivolous lawsuits.
- Essential person insurance, to protect a company from the economic loss incurred when a key employee or manager dies.
What are some types of Universal Life Insurance?
Single Premium Universal Life Insurance
A Single Premium universal life insurance is paid for by an individual, significant, payment. Depending on your policy the wording and specifics might vary, however, for the most part, single-premiums mean just that one large initial payment.
The universal life insurance policy remains valid as long as the cost of insurance has not drained the account. These policies were extremely popular up to and until the late 1980’s. This is because life insurance is usually considered to be a tax-deferred plan. This means that any interest earned in the policy was not regarded as taxable as long as it actually remained in the policy. Additional cash withdrawals from the policy were then taken out principal, meaning that tax-free withdrawals of at least a percentage of the cash value were an option. This was until 1988. In 1988, there were changes made to the tax code, and any single premium policies that were purchased after that were considered to be a “modified endowment contract.” These policies were subject to a much less advantageous tax treatment. Single Premium Universal Life Insurance Policies that were purchased before the change in code were grandfathered in and were are not subject to the new tax law (unless the policy was written with a “material change” clause in it). It should be noted that a modified endowment contract is determined by the total premiums that are paid in a 7-year period. However, it is not defined by a single premium payment.
Fixed Premium Universal Life Insurance
Fixed premium universal life insurance is paid for through a series of periodic premium payments that are associated with a no-lapse guarantee in the life insurance policy. Sometimes the policy guarantees are part of the base policy, and sometimes the guarantee is part of an additional rider that can be added to the life insurance policy. Usually, these payments only take place during a shorter time span than the life insurance is actually valid.
Since the base life insurance policy is inherently based on a specific cash value, the fixed premium policy only works if it is connected to a guarantee. If that guarantee is lost, the policy reverts to flexible premium status. Moreover, if the guarantee is lost, the planned premium payment may no longer be enough to keep the life insurance coverage valid and active. If the experience of the plan is not as positive as predicted, the universal life insurance account value at the end of the life insurance contract’s period may not be adequate to continue the policy as it was initially written. In this case, the policyholder has two choices:
- Leave the policy alone, and let it potentially expire early (if COI charges deplete the account).
- Make additional or higher premium payments, to keep the death benefit level, or lower the death benefit.
Flexible Premium Universal Life Insurance
Flexible Premium universal life insurance allows the applicant to make payments and vary their premiums within specific limits. In order to remain active, the universal life insurance policy must have enough available cash value to pay for the cost of insurance. It should be noted that if the policyholder skips payments or has been paying less than what was initially planned, the policyholder can expect higher fees. It is recommended that policyholders request projections from the insurance company so that they can adequately plan out future payments.
Additionally, flexible premium universal life insurance may offer a variety of different death benefit options. These often include:
- A level death benefit (often called Option A or Option 1, Type 1, etc.)
- A level amount at risk (often called Option B, etc.); this is also referred to as an increasing death benefit.
Policyholders also have the option of purchasing flexible premium life insurance with a large initial deposit, after that making payments irregularly.
It is not uncommon for people to use universal life insurance, more specifically cash value life insurance, as a source of benefits. Some, but not all of these benefits include collateral assignments, loans, and withdrawals.
Collateral assignments are generally placed on life insurance in order to guarantee the loan upon the death of a debtor. If a collateral assignment is put on life insurance, the assignee then receives any amount due to them before the beneficiary is paid. If the case is that there are multiple assignees, they are all paid based on the date of the assignment before the recipient sees anything.
The majority of universal life policies have an option to take a loan out on specific values associated with the universal life insurance policy. These loans require those interest payments to the insurance company. The insurance company charges interest on the loan because they are no longer able to receive any investment benefits from the money that they loaned to the policyholder.
The majority of universal life policies come with an option to withdraw cash values rather than take a loan. The withdrawals are also subject to contingent deferred sales charges. They might also add additional fees associated with them; the contract will define these. It needs to be remembered that any withdrawals that are made will permanently lower the amount of death benefit from the contract at the time of the withdrawal.
Universal life insurance is one of the most in-demand forms of life insurance. For many people, the concept of being able to take out a loan or withdraw from the actual cash value is highly appealing. However, this has to be done with proper thought and research. The last thing that you want is to take out too much of the cash value that you are negatively impacting your life insurance death benefit.