If you are looking for life insurance, you should know that there are several types, and some are better suited for certain circumstances than others. If you want insurance for a specific period of time, the most suitable option is term or fixed-period insurance. On the other hand, if what you are looking for is insurance that will be with you for the rest of your life, the best option is a permanent life insurance.
Among permanent insurance options, some are more traditional and rigid, while others offer more flexibility. If you are interested in having a policy that adjusts to your needs instead of having to adjust yourself to its needs, the most suitable option for you is universal permanent life insurance. In this article, we will explain what universal life insurance is and how it works.
Permanent Life Insurance: Table of Contents
What is Universal Permanent Life Insurance?
Permanent life insurance is a product that is purchased by the insured with the intention of keeping it for a large portion of his or her life. Insurance companies take into account the fact that the average life expectancy is very long in developed countries, and as such, they design policies intended to be paid over the course of many years with high payouts, to be made to the people or institutions designated by the insured at the time of his or her death.
There are different types of life insurance under the umbrella of permanent insurance. In general, they all function in a similar way, but they differ in terms their flexibility and the insured's ability to modify the policy.
Classic permanent life insurance is what is known as whole life insurance or traditional life insurance. In this type of insurance, premiums and payout remain the same, so there are few changes and the insurance behaves in a predictable and stable way.
If the insured wants to have more control over his or her money and take a little more risk, they can choose variable life insurance. In this case, part of the money from the premiums is allocated for investment in equity products, which implies that part of the final payout will fluctuate according to the profits or losses of these investments.
Finally, there the different types of universal life insurance (as well as the universal-variable combination). In a universal type of life insurance, you will have many options that you can modify according to your preferences and needs. Most importantly, you can modify the monthly premium payments to adapt them to your specific financial situation. For example, if you need to pay less for a period of time because you need the money for something else, this type of universal life insurance allows you to adjust your premiums and pay a lower amount. In some cases, you can even suspend payment completely for a period of time.
Of course, variations in premiums can change the policy value, or the final payout. Therefore, it is important for you to understand how universal life insurance works in detail.
In addition to the option of modifying premiums, variable insurance also allows you to modify the so-called death benefit or payout. This way, the cost of insurance varies relative to the final payout total.
To allow for this flexibility, universal life insurance has an investment instrument such as a savings account that generates guaranteed interest. The insurance company turns to this money if and when premium payments are reduced. In the case of the universal-variable life insurance category, this account can be an investment account with equity financial products.
How Universal Life Insurance Works
Unfortunately, "flexible" often also means "complicated," so it is important for you to fully understand how this type of universal life insurance functions. These policies have several elements in common with other types of permanent life insurance, but in some cases, the differences are significant. These are the main components and distinctive features:
- Qualification. As with any permanent life insurance, the insurer will ask you to go through a qualification or underwriting process where you provide details about your health and lifestyle habits. Your age is important, too: the younger you are, the easier it will be for you to obtain insurance.
In the qualification process, it is very important to be candid and answer the questions asked by the insurer honestly. One of the biggest mistakes made when taking out a life insurance policy is hiding information, because if the company discovers the truth, they can void your policy. Do not leave out anything and make sure to take all the tests the company requires, which may include blood tests, x-rays, and other medical exams.
- Payout. The payout, or death benefit, is the money that will be collected by your beneficiaries if you die. You should know that this money is tax-free. Remember that if you turn 95 or 100 years of age, the policy could reach what is called “maturity” and you would collect the payout directly, even if you are still alive.
In the case of universal life insurance, the payout total can be adjusted to fit your needs. If you prefer to pay lower premiums, you may do so by reducing the death benefit. And if you increase the payout, your monthly premiums may increase. You may be interested in reducing the benefit if your and your children’s or successors’ lives are already settled. If this is so, you can request that the payout be reduced and you will pay lower premiums.
- Beneficiaries. These are the people or institutions that will collect the payout if you die (unless you collect it yourself when the policy matures). You can always change them and choose other alternative beneficiaries that will collect if the originals die; you can designate secondary and even up to tertiary beneficiaries, who would be third in line to access the money. Choosing your life insurance beneficiaries is quite important and should not be done without proper planning. Many people name a trust fund as beneficiary, which then manages the money according to their instructions. Others prefer the money go to make up part of their inheritance. If you choose the second option, you should know that inheritances go through complex legalization processes that could significantly delay the payout of the money to your inheritors. In any case, remember to always notify your beneficiaries that they have been designated so they can claim the payout if you die.
- Premiums. Premium flexibility is the big advantage to universal life insurance. You can choose to pay a monthly minimum when it suits you or suspend payments for a specific time period if you cannot afford the cost. Or, on the other hand, you can pay the full amount allowed by the contract and pay off premiums in advance so you do not have to pay them in the future. This ability to choose is very convenient because it can help you to overcome times of financial difficulty.
Universal insurance allows for fee flexibility because it displaces a part of the risk assumed by the insured: if premium payments are reduced, so is the payment. The policy may even expire if there is not enough cash value in it to cover the insurance and the expenses generated by the policy.
- Savings instrument. Permanent life insurance has savings or investment products. These products take part of the money that you pay in premiums and place it into savings accounts that generate interest, or in investment accounts that generate guaranteed interest. With an investment account, you can also choose what products your money is invested in. This is an important feature of universal life insurance, because the flexibility of the premiums and the payout is linked to the savings generated by the insurance, which accumulates in the form of cash value.
- Cash value. As with all permanent life insurance, policies in the universal category also accumulate what is called “cash value.” This is a quantity that is generated through premium payment. In the first years of your life insurance policy, while you are young, you pay more than what it costs to insure your risk. The money that the company invests to generate your savings comes from this overpayment. Little by little, this quantity accumulates. One part will grow the death benefit, but there will still be a surplus that must be handed over to the insured at a certain time. The insured can then use it to pay off future premiums or whatever he or she likes. In addition, loans against future cash value amounts can be requested. These loans are given at a very low interest rate, but it is mandatory to pay them back. If not, the insurer will use part of the payout to cover them. Further, if you withdraw a quantity greater than the policy value, the policy may be voided.
In the case of universal life insurance, keep in mind that if you decide to suspend or reduce premium payments, the company will take money from your cash value to cover whatever you do not pay. Therefore, check the amount of cash value you have, because the insurer may void your policy if it drops to zero. In this category of insurance, cash value can also be used for a loan. If so, make sure you pay it back: otherwise, your final payout may be noticeably reduced, and if you withdraw a quantity greater than the policy value, the policy may be voided.
Finally, remember that your beneficiaries will not receive any of the cash value, just the payout, so it is important that you manage this money. If not, the company will keep any cash value that you have not collected by the time of your death.
These are the main components of universal life insurance. As you can see, it is an attractive product due to its flexibility and versatility. However, it is also a type of insurance that requires your careful attention to avoid losing coverage or guarantees.
In some cases, to avoid problems with expired or voided policies, universal life insurance includes a no-lapse premium benefit or secondary guarantee clause. This option prevents the policy from expiring even if the cash value falls below zero. It is a useful clause in that it covers any kind of alternative risk, but includes an additional set amount that must be paid aside from the customary premiums.
In addition, permanent insurance tends to include other clauses that modify its basic functioning. In general, these premiums make the insurance more expensive, but provide other benefits. The most frequent clauses are the following:
- Accidental death clause. If you die in an accident, your beneficiaries receive an extra payout amount.
- Accelerated death clause. If you are suffering from a serious illness and have a life expectancy of less than a year, you can ask for the benefit and collect it.
- Waiver of premium for disability clause. If you suffer from a disability that prevents you from generating income, this clause exempts you from paying premiums.
Understanding these fundamental concepts about how universal life insurance works, you are now well-equipped to choose a policy. But, you should know the basic formats offered by insurance companies beforehand.
Types of Universal Permanent Insurance
When choosing this type of insurance, there are several possibilities. The varying degrees of flexibility of the policy determine its division into three types of universal permanent life insurance:
- Single premium universal life insurance.
The most basic (and least popular) type is called single premium. This is an insurance policy paid by a single initial premium that pays for the coverage and the contributions required to generate the cash value. In many cases, these policies allow subsequent contributions to be made to their cash value. This option is interesting if you have a significant quantity of money available and you want to put it in a relatively straightforward product that will produce certain savings and provide extra money in the long term. By paying all of the cost at once, this type of policy allows cash value to accrue very quickly and savings to be generated rapidly.
- Fixed premium universal life insurance
In this case, periodic premium payments are set that cannot be modified. Payments can be scheduled over a specific time period, so you can quickly finish paying off the policy this way. In other cases, they are set for the entire life of the policy. Either way, the policy will have a no-lapse guarantee, which means that it remains in effect despite missing payments.
- Flexible premium universal life insurance.
The third category lets you vary the premiums within certain margins. You can always modify the amount you pay for the premiums, but remember that it is important for you to accumulate cash value. If you stop paying and the cash value is insufficient to pay the cost of the insurance not being covered by your premiums, your policy could expire.
Based on these foundations, insurance companies can modify certain details to nuance and enhance universal life insurance policies. In essence, though, the policies outlined above make up the types of universal life insurance available.
Advantages and Disadvantages of Purchasing Universal Life Insurance
Now that you know how many types there are and how they function, you should know what advantages are offered by universal life insurance. They are:
- Flexible payment. The option to pay more or less relative to your needs is probably the most significant advantage of universal life insurance. And your coverage is guaranteed as long as your insurance maintains its cash value, even if you are paying the minimum or nothing at all. Cash value can also be used to amortize premiums, but only if you are careful not to deplete it or cause it to fall below a certain limit, because this could lead to the expiration of the policy. If you are interested in large savings, it is recommended that you pay higher premiums while you are still young. This way, cash value will grow faster and you will have more available sooner. In addition, you'll be able to reduce the premiums when you are older and want to use your money for other purposes.
- Guaranteed interest. This type of universal life insurance uses savings accounts that guarantee minimum interest that never falls below a certain level. Therefore, these instruments are very valuable for saving and many people purchase them for this purpose.
- Death benefit options. The flexibility of universal life insurance allows you to have different options when determining the payout for your insurance. You can choose a level or increasing death benefit. In the former, the payout will always be what has been stipulated in the nominal value of the policy. In the latter, the increasing or incremental death benefit, your beneficiaries will receive a payout for the nominal value of the policy plus the value of the savings account. Naturally, the cost of the premiums depends upon which option you choose.
- Adjustable payout. In addition, within certain limits, you can adjust the quantity to be paid in terms of the death benefit. For example, if your financial situation improves and you believe you will not need such a high payout, you can request that it be reduced, which will also mean a decrease in your premiums. This is an option embraced my many people whose lives are already settled and who do not have dependents.
On the other hand, if you want more coverage, the insurance company may ask you to go through the qualification process again with new medical exams.
In terms of disadvantages, consider the following:
- The added value is not guaranteed, because you can spend it amortizing premiums or taking out loans. This may cause your added value to quickly drop, and it may not recover as quickly afterwards. If you have made a downward modification to your premiums, it will take much longer to recover this value. Therefore, always keep this balance in mind so that your insurance maintains its effectiveness and continues to accumulate cash value.
- Responsibility. Universal insurance allows you to make many decisions, but this requires knowledge, information, and responsibility. The idea of skipping a payment when it is convenient is very attractive, but you must have the discipline to start paying again or you could put your insurance at risk.
- Complexity. These policies tend to be more complicated than, for example, whole life policies. That is why the premiums are also cheaper. This complexity also makes understanding the insurance mechanisms more difficult and can cause you frustration if your savings are not what you expected. Do your research properly when you are underwriting your insurance.
- Taxes. If there is still an unpaid loan when you die that is higher than what is covered by your payout, you could be subject to taxes. If you cancel the policy, the income that you receive from your added value will pay the normal taxes (in case of normal access to the added value, the taxes are deferred).
- Expenses. Insurance also implies fixed expenses and costs. Some typical examples are administrative costs, commissions, or an extra fee for surrendering a policy.
Now you know how universal permanent insurance works and the features and advantages that go along with it. If you are thinking about taking out life insurance, consider this option among one of the most attractive and affordable, as well as one that gives you more control over your money. Always remember that it is advisable to request several quotes and discuss with an expert insurance agent who will explain every detail of the insurance to you before purchasing a policy.
This article was updated on July 24, 2018.
