How does universal life insurance work?

You may have heard of universal life insurance, or may even own a policy, but are you familiar with how it actually works or what makes it unique? As with any life insurance policy, its main purpose is to protect family members from the financial impact of losing a loved one. However, there are significant differences between universal life insurance and more traditional life insurance. 



How long does it last?

Universal life policies are permanent, meaning that as long as you’re making your premium payments, you can keep your policy for as long as you live. If you choose to cancel your policy before you pass away, you may receive money back from the cash value your policy has accumulated over the years.

Cash value

A great benefit of having universal life insurance is the ability to build that cash value we mentioned earlier. Over time, your policy will earn value that you can access called cash value. As this cash value accumulates, it also earns interest. You can make withdrawals, but there are tax implications and implications for the policy you own. Another route you can take with your policy’s cash value is taking out a loan on it with the intent of paying the value back and, thus, not affecting your policy in the same way as a withdrawal. 

Premium payments

Typically, universal life insurance offers level premiums that, as long as payments are made, don’t change throughout life. The price you pay when you’re 30 is the same as the price you pay when you’re 70. The amount you pay can be calculated based on a number of factors such as your age or risk level (such as smoking).

So, where does the cash value we mentioned earlier come in? Since you’re paying a level premium, when you’re young, you’re accumulating cash value and when you’re older, you’re depleting some of your cash value to prevent increases in premium as you become more expensive to insure. Because of this cash value, you actually have flexibility to adjust your premium if you need to skip a payment or make a reduced payment. But, much like taking out a loan on your policy, this can have long-term effects on the policy.

Death benefit

The death benefit is money paid to the beneficiary of a life insurance policy after the policyholder passes away. As with universal life premium payments, the death benefit is also flexible and can be increased or reduced based on your needs. For example, you may want to increase your death benefit while your children are young and have many future expenses to cover. However, once they’re out of the house and financially independent, you may choose to reduce your death benefit to only cover your funeral and your spouse’s living expenses. 

Some universal life policies also offer living benefits which are commonly used to cover the costs of long-term care (LTC ). As the name implies, long-term care is the need to receive care for an extended period. Your living benefits can be used for home healthcare, adult day care or assisted living. As people continue to live longer, there is an increasing need for long-term care. However, long-term care is not just for the elderly. In fact, 40% of people currently receiving LTC are under the age of 65.  With the right policy, you can receive living benefits and your beneficiary can also receive a benefit when you pass away. 

If your employer offers universal life insurance, having this basic knowledge is a great starting point for asking additional questions during voluntary enrollment. Keep in mind that there are pros and cons to all types of life insurance, but being informed about your options can help you maximize your protection and give you and your family peace of mind.