In this segment
Learning about interest
against your cash value
Deciding on death benefits
Determining the pros and cons of
Universal life insurance
Universal life insurance
provides flexibility to policyholders. It's similar to whole
life, in that you have a cash value that grows, and it
encompasses a term life policy, where you decide the terms
and renew the policy annually. However, Universal life isn't
simple like term insurance - or even like whole life. In
fact, balancing the options can be quite complicated. So in
this segment, I'll discuss the basics of Universal life
insurance, the elements that you get to compare for your
particular needs, and your options in designing the right
policy for you.
How Universal life works
life insurance is a form of whole life insurance - but with
much greater flexibility. Like life, you have two
components: a term insurance policy and an investment
account from which the term insurance premiums are paid. But
with Universal life, you get to choose your options, and the
choices are generally laid out in front of you. You know how
the premiums may change the death benefit and cash value,
and it's much clearer how much of the premiums go toward
your insurance protection, how much toward your cash value,
and how much toward administrative expense (including
Start with a planned death benefit that you
work out with your agent's help. You determine your planned
premium, based on how much you can afford and the cost of
the insurance. The company subtracts and expense charge
based on its fees, usually a fixed percentage of the
premiums. You're left with a cash value that generates
But understanding Universal life doesn't end
there. From that cash value, the company subtracts the
current cost of insurance (the mortality charge), including
the charges for any options (or riders), and monthly
administrative expenses. Then the company adds in interest
that your investment money earns. You're ending cash value
is not accumulated value that belongs to you when you
terminate the policy (or to your beneficiary when you die).
Often, companies charge you may surrender charge to
terminate the policy, leaving you with the surrender value
the surrender charge is usually a small percentage of the
total cash value.
Other aspects of Universal life to
All the earnings in your investment
account are tax-deferred.
If you stop paying premiums,
the Company continues to pay the premium for you by
deducting from your policy's cash value. The company does so
until no cash value is left (these deductions are usually
called automatic premium loans). This is one way to continue
coverage without paying premiums.
The interest rate is a
fixed rate, although it may be a tiered interest rate, in
which a part is paid at one rate while the balance is paid
at a higher rate. For example, your interest rate may be 4%
for the first $1000 and 7% for the balance.
withdraw money that has accumulated in your cash value. If
you do, your death benefit decreases because it depends
partially upon the accumulated cash value.
You can borrow
against the cash value of your policy at a fixed rate,
generally below market rates.
If you increase your
coverage, you may have to re-qualify by taking a medical
You probably have to pay a termination fee or
surrender charge (back-loading). This fee decreases each
year you have the policy, but it does lower the amount of
your cash value.Generating Interest
companies frequently have two or more interest rates that
kick in at different levels. For example, the guaranteed
interest rate may be 4% on the first $500 and 7% on balances
over $500. With a balance of almost $8,000, the total
interest is just under 7%.
When you're choosing a policy
or company from which to buy your Universal life policy,
take the one with the highest guaranteed interest so that
your cash value grows most quickly.
The interest earned
continues to increase and eventually will equal and then
exceed the amount you contribute. At this point, the money
you pay is, in effect, going directly into your own account.
The interest rate is calculated daily, so you get compounded
interest (interest on your interest). For a policy with an
interest rate of 7%, the annual percentage rate (APR) is
actually more than 8%.Borrowing Against Your Cash Value
Universal life policies allow you to borrow against your
cash value, usually at interest rates below what you can get
elsewhere, even for loans secured against other assets.
However, borrowing against your policy generally lowers the
interest you receive on your cash value, making it equal to
or less than the interest at which you borrow.
The amounts of your death benefit, accumulated
cash value, and premium are all interrelated with Universal
life. The more you pay per month in premiums, either the
more protection you're buying or the more cash value your
building. You can't have both. The higher the protection you
buy, either the higher your premiums or the lower your cash
value. In the more cash value you want to build, either the
higher the premium or the less protection you're buying.
Because your primary goal in buying insurance is protection,
your primary consideration should be the amount of the death
benefit. Cash value and your premium cost should be
secondary factors, but clearly, your premium should be in
line with how much you can afford to pay.
If you want a Universal life policy and the
leaves that you can afford the premium, you need to balance
the following three considerations to determine your cash
Determine how much you can afford from your
Decide how much protection you want to
Balance the amount of protection you want to
purchase with the amount of premium you can afford.
invest in a life insurance policy to be covered in case you
die, not because life insurance is a good investment. You
can generally make more money by putting your money into
other investments.Pre-paying your premium
Universal life, you can buy in up-front by putting a
significant sum into your account, which allows your cash
value to increase more because your account is starting at a
higher level. Pre-paying also allows you to lower your
premiums because the accumulated cash value is earning more,
which means that more of your earnings can contribute to the
cost of the insurance. On the other hand, prepaying also
means that you must take a lump sum of cash from somewhere.
Is pre-paying for you? Not likely, unless you really want
insurance but can't afford monthly payments. People have
generally used pre-paid insurance as an investment to build
cash value without incurring any tax consequences. But with
IRAs, Roth IRAs, and 401(k)s, chances are you won't be
interested in this option.
Summing it Up
the pros and cons of Universal life insurance.
A lot of flexibility - you can tailor the premiums,
cash value, and death benefit to suit your needs.
Complicated terms and options; you have to depend on your
agent to guide you to the best plan for you.
remains constant for the entire time you're covered, and you
can opt for either a fixed death benefit or an increasing
Premiums are considerably higher than for
term insurance, and if your death benefit remains fixed, you
actually reduce the accumulated cash value.
be paid-up by the profits from your cash value, and most of
your premiums are going to you.
Whether from your monthly
budget or your accumulated cash value, you're still paying
the premium. Not appropriate as an investment due to poor
rate of return.
Lifetime coverage and no medical exam
(unless you make changes to the policy).
coverage may become unnecessary later in life when you have
no dependent beneficiaries.
earnings, and if you decide to cash-out, the premiums you
paid reduce the gain.
Returns aren't as high as other
tax-deferred plans such as IRAs and 401(k)s (which allow you
to invest your money where ever you want.
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