Universal Life Insurance Pitfalls

Universal life insurance gives people permanent coverage to provide financial protection, while also building up cash value in the policy – and it offers the most flexibility to adapt the policy to the policyholder’s changing needs over time. Universal life insurance offers great flexibility, but it also requires policyholders to be vigilant about the details of managing their policies. There are several key mistakes and pitfalls that people can encounter when buying universal life insurance.

Major universal life insurance pitfalls include:

  • Skipping too many payments – The biggest benefit of universal life is its flexibility in scheduling payments. But beware of getting too “flexible” for your own good…
  • Setting minimums (or maximums) at the wrong level – Universal life insurance contracts include agreements on minimum (and maximum) premium payment levels – make sure these are set at the right levels.
  • Reducing the death benefit too soon – With universal life, you can lower the policy’s death benefit amount in favor of more cash value – but be careful, since it’s not always so easy to raise the death benefit again.
  • Not paying attention to details – Universal life creates more responsibility for the policyholder. If you’re not comfortable with that, choose whole life instead.
  • Unexpected fees – Sometimes the insurance company’s internal fees will exceed the interest rate paid to the universal life insurance policy’s cash value.
  • Missing a chance for optional riders – Whether you need a No Lapse Guarantee or other riders, it’s often best to add them early – or even when you first buy the policy.

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Skipping Too Many Payments

Universal life insurance is great for giving the policyholder control over when and how much to pay for premiums. As long as you make a certain minimum level of payment, you have the option of using the accrued cash value in the policy to make additional payments.

The pitfall is that some policyholders get too carefree about payments – and they miss enough payments that their policy’s cash value drops too low to make additional premiums. This can cause the policy to lapse, leaving the policyholder’s family unprotected in case of the policyholder’s death.

Setting Minimums (or Maximums) at the Wrong Level

When buying a universal life insurance policy, the contract will contain details on the minimum payment levels that the policyholder needs to meet. Make sure to set these levels at a place that is comfortable for you – for example, if your income varies from month to month, try to adjust the payment schedule so that bigger payments are due when you have the money to make them.

At the other end of the spectrum, if you prefer to make occasional large payments, make sure the maximum payment level is high enough to accommodate these.

Reducing the Death Benefit Too Soon

Many universal life policyholders tend to reduce their death benefit as they reach a stage of life where their children are grown. These people now have less interest in financial protection for their dependents, and more interest in getting a bigger cash value for their other financial goals. Be careful not to make this move too soon. Death benefits should only be reduced if the policyholder is certain that his/her dependents will no longer need the higher level of protection.

The reason is that while it’s easy to reduce the death benefit (in exchange for higher cash value), it’s not so easy to go the other direction and raise the death benefit. Policyholders might have to go through underwriting again, or prove that they are in good health. There might be added fees or higher premiums as a result of raising the death benefit.

So although universal life insurance makes it possible to lower (and raise) the policy’s death benefit, proceed carefully – it’s easier to move in one direction than the other.

Not Paying Attention to Details

The biggest mistake, in general, that policyholders make with universal life insurance is to not pay sufficient attention to the details of their policies. Universal life insurance shifts some of the responsibility of managing the policy to the policyholder. Instead of having fixed premiums, an unchanging death benefit and guaranteed cash value (as is the case with whole life), universal life policies fluctuate depending on the preferences of the policyholder.

This makes it ever more important for policyholders to understand the details of their policies – understanding how many payments they can afford to skip, what is the current amount of their cash value, and what happens if the policy lapses.

Unexpected Fees

The cash value of a universal life insurance policy, like most whole life insurance policies, earns a rather low rate of interest. The challenge with universal life insurance is that depending on the insurance company, sometimes the insurance company’s internal costs and mortality costs (the cost of paying claims from policyholders who have died) exceed the interest rate that accrues to the cash value.

This means that in any given year, a policy’s cash value might not grow at all (or might even shrink). This is another example of the details that universal life policyholders need to track and understand.

Missing a Chance for Optional Riders

Because of their extreme flexibility, universal life insurance policies often come with optional riders – additional coverage levels or special features that can be added to the policy for a fee.

Riders can include anything from term life insurance for the policyholder’s children to additional coverage for accidental death, or even long-term care riders that allow the policyholder to collect advance payments from the death benefit in case of serious health problems and end of life care.

The pitfall is that many policyholders don’t buy these riders until it’s too late. Some riders can only be purchased at the time that the policy is first written – or else there might be additional fees (similar to what happens when raising the amount of death benefit). 

Optional riders can be a great way to strengthen a universal life insurance policy or add additional features – but as with all other life insurance decisions, it’s best to plan ahead.

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