Universal Life Insurance for Dummies

Universal life insurance policies are fairly new. Unlike temporary term life insurance, universal life insurance is permanent. As long as the policyholder pays the premiums on time, it remains in force until maturity. Maturity occurs when the insurance company that sold the policy pays the death benefit to the beneficiary. In some cases, maturity occurs when the policyholder turns 95 or 100. A policy that matures based on the age of the policyholder depends on the state in which the universal policy was sold. If the policy matures due to age, the policyholder is paid the value of the account, according to the contract.

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How it Works

A universal life policy normally pays the policyholder a guaranteed return, although it might be smaller than the return guaranteed by a more traditional whole life insurance policy. Universal life is like whole life in that some of the premium covers the cost of the insurance. The insurance company then invests the balance of the premium.

While the account can build cash value over the life of the policy, the policyholder must trust that the money managers are investing in appropriate, high quality sectors such as T-Bills and T-Bonds and safe equity mutual funds. Universal life applicants are encouraged to confirm that the insurance company from which the policy is being bought has an A+ or higher credit rating from Standard and Poor’s Moody’s or one of the other credit rating agencies.

An advantage of a universal life insurance policy is the option to vary the amount of the premium and the premium payment schedule to meet financial needs that may change from one year to the next. For example, a universal life insurance policyholder can reduce the payment if he or she needs to because of an unexpected financial situation. He or she might also choose to deduct the premium payment from the cash account. The risk to paying the premium from the cash account is that it reduces the amount of cash and could also reduce the death benefit.

Why Choose Universal Life Insurance?

Reputable insurance professionals will always make sure that the universal policies they sell are suited to the clients they sell them to. While universal policies are suited to people who want to ensure that their final expenses are covered, they are typically better suited for those looking for financial and estate planning tools.

Like immediate annuities, universal life insurance policies can also be bought with a single lump sum premium. If the purpose of the policy is to leave cash for a spouse or child or to avoid probate, a universal life insurance policy can be a wise choice. A charity can also be named as the beneficiary on a universal life insurance policy.

But what distinguishes a universal life insurance policy from other investments is that a business owner can deduct the premium as an expense if giving the policy to an employee as a benefit. Business owners who by law or mission statement cannot give employees cash bonuses can usually provide life insurance policies. And, an individual with significant assets or who has a need to protect assets from lawsuits also benefit from universal life insurance policies, as almost all states consider insurance policies and annuities irrevocable contracts.

How the Death Benefit on a Universal Life Insurance Policy Determined?

All insurance policies pay a death benefit. This is the amount paid to the beneficiary upon the death of the policyholder. When buying a universal policy, an investor can choose between two death benefits. One is level and one is increasing.

A universal policy with a level death benefit pays only the face value of the policy to the beneficiary. The amount in the cash account is not paid to the beneficiary, which reduces the cost of the policy to the policyholder.

A universal policy that pays an increasing death benefit pays the face value plus the accrued amount in the cash account. With this kind of option, the death benefit increases each year the policy is in force. However, this means that the cost of the insurance to the policyholder does not decrease over the years the policy is in force. The policyholder pays more for the insurance as he or she gets older. But, as the value of the cash account grows over the years, the death benefit paid out can be larger, and can offset the effects of inflation.

How is Interest Earned on a Universal Life Policy?

A universal life insurance policy is both an insurance and investment product because it pays a death benefit and can either increase or decrease in value. Only a licensed insurance agent who is also a registered securities dealer can sell universal life policies. Universal life policies are regulated by the state and by the SEC (Securities and Exchange Commission.) Because it is an investment product, a universal policy will usually pay a guaranteed return to the policyholder.

The return, however, can be less than that paid on other permanent life policies because managing the investments can be more complicated. Universal life insurance policies are like permanent whole life insurance policies in that the gains for both types of policies grow tax-deferred. Further, they can usually be borrowed against without a tax penalty. The rates charged on the amount borrowed will vary by insurance company.

Those looking to buy a universal life policy, as either their primary insurance or as an investment product, should always make sure the company from which they buy the policy is financially sound and able to meet its future financial obligations. A universal life insurance policy represents a financial liability that may not present itself for many years, if not decades.

If an insured purchases the policy at age 55, the life insurance company may not need to assume the liability for another 20, 30 or more years. Choosing a highly-respected company that is has been rated by A.M. Best, Fitch, Moody’s Investors Services and Standard and Poor’s should allow an investor to purchase the product with confidence.

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