In this guide
Universal life (UL) is a type of permanent life insurance that combines a death benefit with a cash account that earns interest. Unlike whole life, UL usually lets you adjust premiums and sometimes the death benefit. The flexibility has a cost: the policy stays in force only while the cash value is enough to cover monthly insurance charges, so underfunding it can cause the policy to lapse.
Key takeaways
- The NAIC describes universal life as term insurance combined with a cash account that earns interest on a tax-deferred basis.
- Premiums and death benefits can often be changed, but the policy remains active only if the cash value can cover its costs.
- There are several versions: traditional (fixed-rate), guaranteed, indexed and variable. Each puts risk in a different place.
- Illustrations of future values are projections, not promises. Ask what is guaranteed and what is not.
How universal life works
Each time you pay a premium, the insurer subtracts charges and credits the rest to your policy's cash account. Charges generally include the cost of insurance (the pure life coverage), administrative fees and any rider costs. The remaining cash value earns interest. Each month the insurer deducts the charges from the account.
As long as the cash value is enough to pay those deductions, the policy stays in force. If cash value runs low, you may need to pay more to keep it going. That is the key difference from whole life, which generally has fixed premiums designed to keep the policy in force for life. Our article on term vs. whole life insurance compares those two.
Flexible features
- Premium flexibility. Within limits, you may pay more or less than a target amount, or skip a payment if there is enough cash value.
- Death benefit options. Some policies allow a level benefit, or a benefit that includes the cash value. The choice affects costs and cash value growth.
- Loans and withdrawals. Depending on the policy, you may borrow against cash value or withdraw from it. The NAIC notes that policy loans may be available, and unpaid loans can reduce the benefit.
Types of universal life
| Type | How cash value grows | Who carries the risk |
|---|---|---|
| Traditional (fixed) UL | Credited interest set by the insurer, usually with a guaranteed minimum | Mostly the insurer, though credited rates can fall toward the minimum |
| Guaranteed UL | Designed to guarantee coverage to a set age if required premiums are paid, often with limited cash value | The insurer, as long as you meet premium terms |
| Indexed UL (IUL) | Interest is linked to an outside index, such as the S&P 500, with a guaranteed minimum, as the NAIC describes | Shared; crediting formulas include limits |
| Variable UL (VUL) | Cash value is invested in separate accounts; returns are not guaranteed and can fall with the market | The policyholder |
A word on indexed policies
Indexed universal life does not put your money directly into an index. The insurer credits interest using a formula that can include caps, participation rates or spreads. These limits can reduce the credited rate in strong markets, and a guaranteed minimum can protect against losses. Ask for a plain explanation of the formula and what can change.
A word on variable policies
Variable universal life is a securities product as well as insurance, so it is typically sold with a prospectus and regulated by securities authorities in addition to state insurance regulators. Investing is optional, but poor performance can reduce the cash value and require higher payments to avoid a lapse. Read the prospectus and ask about fees.
The risk of lapse
The main danger with universal life is underfunding. If you pay minimal premiums for years, or credited interest is lower than the illustration assumed, cash value can shrink as monthly charges rise with age. Eventually the policy can run out of money and lapse unless you pay more.
Watch out: If a universal life policy lapses, you may lose coverage when you are older and when replacing it is most expensive. Ask your insurer for an in-force illustration or annual statement review every year or two.
Some policies have a grace period, which is time to catch up on payments after the cash value runs low. The length and terms are in your contract. Policy loans can add to the risk because unpaid loans and interest reduce both cash value and the death benefit.
Costs and fees
Universal life has several cost layers, and they are not always obvious:
- Cost of insurance (COI). Typically rises as the insured ages.
- Premium load or expense charges. A percentage taken from each premium in some policies.
- Administrative fees. Monthly or annual policy fees.
- Surrender charges. Fees for canceling during the early years, which can make early surrender costly.
- Rider charges. See life insurance riders explained.
Early cash values may be low or zero, and the NAIC notes that cash values in some policies are low in early years. Our guide to cash value, loans and surrendering explains what happens if you borrow or cancel.
Reading an illustration
Insurers use illustrations to show how a policy might perform. They are projections based on assumptions, such as the credited interest rate or index performance, and they are not guarantees. A good practice is to ask for three views:
- Guaranteed. What happens if the insurer credits only the guaranteed minimum and charges the maximum allowed.
- Current. What happens if today's rates and charges continue.
- Stress test. What happens if rates are lower than today's assumptions, and what premium would keep the policy going to older ages.
Compare how long each version keeps the policy in force. If the guaranteed version lapses in your 70s, understand that you are relying on future rates to keep coverage alive.
Who universal life may fit
Universal life may appeal to people who want lifelong coverage and flexibility, for example to adjust payments through changing income, or who want to leave a legacy or cover lifelong needs. Guaranteed versions are often considered by those whose main goal is coverage for life with a predictable premium. Whether it fits depends on your goals, budget and comfort with complexity.
It may be a poorer fit if you need a large amount of coverage for a limited time, where term insurance is usually simpler and cheaper, or if you cannot commit to funding premiums for years. Not sure how long you need coverage? See how to choose a term length for comparison.
Tip: Ask any agent to explain, in plain language, what premium is required to keep the policy in force until age 100 under the guaranteed assumptions, and what happens if you pay less.
Questions to ask before buying
- What exactly is guaranteed: the death benefit, the interest rate, the cost of insurance?
- What premium keeps the policy in force to the oldest age shown?
- What are all the charges, and can they change?
- What are the surrender charges, and for how many years?
- For indexed policies, what are the caps, participation rates and floors, and can they change?
- For variable policies, what are the fund fees and where can I read the prospectus?
Compare quotes and illustrations from several insurers, and check that agents and companies are licensed with your state insurance department.
Frequently asked questions
Is universal life the same as whole life?
No. Both are permanent, but whole life usually has fixed premiums and a set structure, while universal life offers flexible premiums and a cash account that depends on credited interest or investment performance.
Can a universal life policy lapse?
Yes. If the cash value cannot cover monthly charges and you do not pay enough, the policy can lapse after any grace period. Guaranteed designs reduce that risk if you meet the premium requirements.
Is indexed universal life invested in the stock market?
No. Interest credits are linked to an index, but the money is not invested directly in it. The credited rate is set by a formula that typically has a cap or other limits and a guaranteed minimum.
Is the cash value taxed?
The NAIC says cash value grows tax-deferred. Withdrawals, loans and surrenders can have tax consequences, so ask a tax professional before using the cash value.
Can I change the death benefit later?
Many policies allow increases or decreases within limits. Increases may require new underwriting, and decreases can affect charges and cash value.
Sources
- NAIC – Life Insurance (Insurance Topics)
- NAIC – Life Insurance (Consumer guide)
- Minnesota Department of Commerce – Term vs Permanent Life Insurance
- Insurance Information Institute – How to choose the right type of life insurance
General information only. This guide explains general concepts and is not insurance, legal or financial advice. Rules and prices vary by state and insurer. Check your policy documents and speak to a licensed insurance professional or your state insurance department about your situation.