When you decide that the time is right to get life insurance, the first question you’ll have to answer is whether you want term life insurance or permanent life insurance.
If you’ve decided that permanent life insurance is right for you, you’ll probably want to explore the different options. Under the umbrella of permanent life insurance, universal life insurance is one out of many types of life insurance you’re likely to come across.
The main difference between the term and permanent life insurance (often called “whole life insurance) is the time frame. Term life insurance lasts for a finite period in your life, often between 10 and 20 years, and if you don’t pass away during that period, there’s no payout. Permanent life insurance, on the other hand, lasts until your death as long as you pay your premiums. The policy then pays out to your beneficiaries.
Term insurance is more affordable than permanent insurance, and it’s often the best choice for many people. Note that Fabric sells term life insurance, though we don’t currently offer permanent insurance.
That said, if you’re interested in lifelong coverage, universal life insurance could be a viable choice. It’s one of the more flexible types of permanent life insurance, since you can adjust your death benefit (and thus your premiums) up or down without having to take out a new policy. This typically isn’t possible with term life insurance or other types of permanent life insurance.
Universal life also allows you to secure life insurance coverage until your death with the security of knowing that your premium will stay the same throughout, unless you decide to change it.
“Universal life policies can be a good way to have a level life insurance premium throughout a lifetime,” Alexander Petsis, a Certified Financial Planner at Anthony Petsis & Associates, says. While many people are familiar with term life insurance as an affordable option, he notes, term insurance can become much more expensive if you decide you want a new policy after your prior policy expires. That’s because life insurance gets more expensive as you age, and you’d be reapplying for new coverage when you’re that much older.
Additionally, “universal life tends to have the cheapest cost among permanent life insurance products,” he says.
Universal life policies consist of two parts: the death benefit and the cash value component.
The death benefit is the money your beneficiaries receive when you die.
The cash value component is a bit like a savings account. Each time you pay a premium, part of that premium goes toward “cash value” and it grows. It also earns interest—there’s typically a baseline interest rate, though it can grow at a higher rate depending on market conditions and the details of the policy.
You can choose to pay a level premium throughout the life of the policy. But many universal life policies also have minimum and maximum premiums, and you can pay any amount between the two.
Many people pay larger premiums early in the policy to build up the cash value. Once they’ve reached a certain cash-value threshold, they can:
Use the cash value to pay part or all of their future premiums (if you’re paying the minimum premium, the cash value covers the rest)
Withdraw money from the cash value to cover other expenses
Use the cash value as collateral to take out a loan from the insurer
If you take out a loan, you’ll have to pay it back with interest. If you die with an outstanding loan, your insurer will deduct the loan amount from the death benefit before giving it to your beneficiaries.
If you make a withdrawal, you may have to pay taxes on the money, depending on your policy details. A large withdrawal can also reduce your death benefit.
If you deplete your cash value completely through withdrawals, you’ll need to pay the full premium payment going forward (as opposed to using any cash value to help with the premium payments), or you could lose your policy entirely.
Depending on the terms of your policy, when you die, the remaining cash value may go to your beneficiary or back to the insurance company. Make sure to read the fine print and plan accordingly.
If you’re looking for a lifelong policy that can serve as a savings vehicle with the flexibility to change your premiums and/or your death benefit during the life of the policy, universal life insurance might be a good option.
One situation where universal life makes sense is if you’re a high-net-worth individual who wants to pay for estate taxes that will be assessed after you die. (This only affects estates over $11.7 million for an individual and $23.4 million for a couple in 2021, according to the IRS.)
“This is a strategy for wealthier individuals to create a tax-free life insurance benefit to provide liquidity and tax payments for their large estates,” Petsis says.
Families who have a loved one with special needs might also consider a universal life insurance policy. Petsis says, “As a Chartered Special Needs Consultant®, I often help families plan what sort of legacy they will need to leave for their special loved one to provide for their care. A second-to-die, universal life policy can be a cost-efficient solution to funding this need.”
A second-to-die life insurance policy covers two lives, such as two parents, and only pays out when the second person passes away. “This typically significantly reduces the premium compared to having permanent life insurance on two separate lives, or just one life,” he says.
Finally, universal life could be a good choice if your financial situation is such that you want the ability to increase or decrease your premium and your death benefit relatively easily. It gives you the flexibility to lower your premium (and death benefit) when you run into budgetary constraints, and the ability to raise the death benefit (and premium) when you’re able.
If having a permanent life insurance policy will help you sleep better at night, choosing the flexibility of universal life insurance can help ensure that your policy changes as your life does.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards. This article has been reviewed and approved by a compliance professional who is a licensed life insurance agent.
Fabric by Gerber Life exists to help young families master their money. Our articles abide by strict editorial standards.
Information provided is general and educational in nature and is not intended to be, and should not be construed as, financial, legal, or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. We make no warranties with regard to the information or results obtained by its use, and disclaim any liability arising out of your use of, or reliance on, the information.
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