What Is Universal Life Insurance, and How Does It Work?

Short answer: Universal life insurance is a type of permanent life insurance with flexible premiums and a cash value. FINRA says universal life “provides coverage for the life of the insured and also offers flexible premium payments,” and that the cost of your insurance protection is deducted from the cash or policy account value. If that cash value runs out, the Texas Department of Insurance says the policy could lapse.

What is universal life insurance?

The Maryland Insurance Administration describes a universal life insurance policy as “a type of permanent insurance with a flexible or fixed premium.” The Texas Department of Insurance (TDI) says “Universal life insurance stays in effect until the maturity date, which is usually age 95 or 100, as long as you have $1 or more in cash value.”

What sets it apart is flexibility. The New York State Department of Financial Services (DFS) says universal life “allows you to change or skip premium payments” and lets you change the death benefit. The NAIC’s Life Insurance Buyer’s Guide says “you can choose a flexible premium payment pattern as long as you pay enough to keep your policy in force.”

That flexibility comes with responsibility. DFS says “you will need to actively manage the policy to maintain sufficient funding,” “especially because the insurance company can increase mortality and expense charges.”

How does a universal life policy work?

Here is the basic flow that regulators describe:

1. You pay a premium. DFS says “The company credits your premiums to the cash value account.”
2. Charges come out. DFS says the company periodically deducts its expenses and the cost of insurance, “usually described as the mortality deduction charge.”
3. Interest is credited. TDI says “Most universal life policies earn a guaranteed minimum interest rate on the cash value.” Maryland says the cash value earns interest at the rate “declared by the company annually,” which “will equal or be more than the guaranteed interest rate stated in the policy.”
4. The policy lasts only while it’s funded. TDI says “If your premiums are lower than the cost of insurance, the difference is taken from the cash value,” and “If the cash value reaches zero, your policy could lapse.”

How does universal life insurance cash value work?

The cash value is the account that pays the policy’s charges. FINRA says “The cost of your insurance protection and in some cases other costs are deducted from the cash or policy account value.”

Three things affect how long it holds up:

• Charges rise with age. The Wisconsin Office of the Commissioner of Insurance (OCI) says “The main expense of a universal life policy is the cost of insurance charge,” and “As you age, the rate of the cost of insurance charge will increase.”
• Only some terms are guaranteed. DFS says “The company guarantees a minimum interest rate and a maximum mortality charge,” but “the interest rate and expense and mortality charges payables initially are not guaranteed.”
• What you pay matters. DFS says that “if you pay less, the benefit may be more like term insurance.” TDI says “You might need to pay more in premiums to keep the policy in effect until the maturity date.”

Getting money out has costs, too. TDI says “You might have to pay a surrender fee if you withdraw the money early,” and “if you withdraw more money than you paid in premiums, you’ll probably have to pay taxes on it.” Ask a tax advisor before you withdraw or borrow.

What are the main kinds of universal life insurance?

Wisconsin OCI says universal life “comes in many varieties,” and its list includes “fixed universal life insurance,” “indexed universal life insurance” and “guaranteed universal life insurance.”

If you hear “current assumption UL,” ask the agent what the label means for that specific policy. For indexed policies, start with what IUL insurance is and how it works.

What is guaranteed universal life insurance?

The key feature is the no-lapse guarantee described above, and TDI adds a catch: “You must pay your premiums on time for the guarantee to apply.” Don’t rely on the word “guaranteed” in a product name alone. Ask the agent to show you, in the policy and illustration, what is guaranteed, how long the guarantee lasts, and what happens if you pay late, pay less or skip a payment.

Universal life insurance for seniors: what should you know?

Term coverage can be harder to find later in life. TDI says “Most companies offer term life insurance only up to a certain age, usually 70 or 80.”

If you’re comparing universal life or guaranteed universal life, keep in mind:

• Charges climb as you age. DFS says “the mortality charges increase, as you become older.”
• Underfunded policies can lapse. Wisconsin OCI warned that many universal life buyers “found that their policies had lapsed (were no longer in effect) with little to no value or they were required to pay large additional premium payments to keep their coverage in effect.”
• Check an older policy every year. Wisconsin OCI says policyholders “can request, free of charge, an updated ‘in-force illustration’ once a year,” and advises asking your insurer or agent “every year what premium level, based on current conditions, would allow your coverage to continue to your desired date.”
• Be careful about replacing a policy you already own. Maryland says “Seniors are often targets of insurance fraud,” and that “Changing to a new annuity or policy may cause you to lose money over the first three to five years.” TDI says “It’s illegal for an agent to replace a policy just so the agent can get a new commission.”

If you mostly want a smaller policy for funeral costs, compare life insurance options for seniors over 80.

Universal life insurance vs. whole life: what’s the difference?

FINRA says whole life premium payments “typically remain the same for the life of the insured,” while universal life “offers flexible premium payments.” DFS says universal life gives you “maximum flexibility,” but you will need to actively manage it. For a side-by-side look, see IUL vs. whole life insurance.

Questions to ask before you buy a universal life policy

1. Can I see the guaranteed and non-guaranteed columns? The NAIC says a basic illustration shows both guaranteed and non-guaranteed elements, and that a non-guaranteed element “is not guaranteed or determined at issue.”
2. How long does the policy last on guaranteed values if I pay only the planned premium?
3. What are all the charges, and what is the surrender charge schedule?
4. Does it have a no-lapse guarantee, and what are its conditions?
5. What’s the highest premium I might have to pay? The NAIC Buyer’s Guide suggests you “Ask what might be the highest premium you’d have to pay to keep your coverage.”
6. Can I return it? The NAIC Buyer’s Guide says that if you’re not satisfied, “you can return it for a full refund within a certain period,” and “The review period usually is stated on the first page of the policy.”
7. Are the agent and company licensed? TDI says “Make sure the agent and company are licensed to sell insurance.”

The bottom line

Universal life insurance is permanent coverage with flexible premiums and a cash value that pays the policy’s charges. Those charges rise with age, only some terms are guaranteed, and TDI says the policy could lapse if the cash value reaches zero. Compare the guaranteed values before you decide. The licensed agents who work with us offer IUL policies: call (888) 603-7464 to compare options and get a quote, with no obligation. Here’s how calling RestAssured works.

RestAssured is not an insurance company or an insurance agency; we connect callers with independently licensed insurance agents. RestAssured doesn’t give tax or investment advice.

Frequently asked questions

What is universal life insurance?

Universal life insurance is a type of permanent life insurance. FINRA says it provides coverage for the life of the insured and offers flexible premium payments, and that the cost of insurance protection is deducted from the cash or policy account value.

How does universal life insurance cash value work?

The New York State Department of Financial Services says the company credits your premiums to the cash value account and deducts its expenses and the cost of insurance from it. The Texas Department of Insurance says that if your premiums are lower than the cost of insurance, the difference is taken from the cash value, and if the cash value reaches zero, the policy could lapse.

What is guaranteed universal life insurance for seniors?

Wisconsin’s insurance regulator lists guaranteed universal life as one variety of universal life. The Texas Department of Insurance says some universal life policies have a no-lapse guarantee that keeps the policy in effect if your payments aren’t enough to cover the cost of insurance, as long as you pay your premiums on time. Ask the agent exactly what is guaranteed, for how long, and what you must pay to keep the guarantee.

What is the difference between universal life insurance and whole life?

FINRA says whole life premium payments typically remain the same for the life of the insured, while universal life offers flexible premium payments. The New York State Department of Financial Services says universal life gives you maximum flexibility, but you will need to actively manage the policy to maintain sufficient funding.

Can a universal life insurance policy lapse?

Yes. The Texas Department of Insurance says that if the cash value reaches zero, your policy could lapse. Wisconsin’s insurance regulator says many universal life policyholders found their policies had lapsed with little to no value, or had to pay large additional premiums to keep coverage.

Sources

• Insurance (life insurance types), FINRA
• Life insurance guide, Texas Department of Insurance
• Types of life insurance policies, New York State Department of Financial Services
• Consumer Alert related to Universal Life Insurance, Wisconsin Office of the Commissioner of Insurance
• Life Insurance, Maryland Insurance Administration
• Life insurance illustrations, National Association of Insurance Commissioners
• Life Insurance Buyer's Guide, National Association of Insurance Commissioners

This article is for general education. Policy features, prices and eligibility vary by insurance company and state; your agent will explain the specific terms of any policy before you apply.