What is universal life insurance?

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Life insurance should be part of your financial plan, especially if you have loved ones who rely on you financially. While term life insurance covers you for a certain number of years, such as 10 or 30 years, some people may find a permanent life insurance policy like universal life insurance has more advantages for their long-term financial goals.

Learn more about how universal life insurance works and how it compares to the other types of life insurance.

What is universal life insurance and how does it work?

Universal life insurance is a type of permanent coverage. Unlike term life insurance, a universal life policy doesn’t expire. You’re covered as long as you’re alive and pay your premiums. All permanent life insurance policies come with two main parts:

The death benefit
The cash value

The death benefit amount is the cash payout that your beneficiaries receive tax-free after you pass away. The cash value portion is yours and you can access it during your lifetime as you need.

Universal life insurance policies are one of the most popular types. A 2020 LIMRA study found that universal life finished a close second in life insurance policy market share.

Catherine Theroux of LIMRA said consumers shopping for life insurance like the combination of investing and a guaranteed death benefit.

Types of universal life insurance

Every universal life premium payment goes toward fees, the death benefit and the cash value. The cash fund grows over time, much as a savings account grows if you regularly deposit funds into it.

The amount of the premiums that goes to the cash value depends on the type of universal life insurance. Your cash fund’s growth potential also depends on the type of universal life insurance.

The universal life subcategories are:

Fixed or guaranteed universal life: This has the lowest risk. The bulk of your premium goes to ensuring the death benefit. A minimal amount of your payment goes to the cash value fund, which earns “a money market rate of interest,” according to the Insurance Information Institute.
Index universal life: Medium in risk, you have the opportunity to contribute more to the cash value. Your cash grows based on the performance of one of the stock market indexes, such as the S&P 500 or Nasdaq. Your balance could drop and increase based on stock market volatility, although most IUL policies have a guaranteed minimum and maximum return rate.
Variable universal life: The riskiest to your cash value, you can choose to invest in mutual funds that own multiple stocks.

Universal life insurance flexibility

One main advantage of a universal life insurance policy is the flexibility to adjust the death benefit amount and the frequency of your payments. You don’t have to make a payment every month.

You may opt to:

Make quarterly payments
Increase contributions to grow cash value faster
Pay less in premiums to reduce the amount of your death benefit or cash fund
Apply part of the cash value to pay your premiums

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Who is universal life insurance best for?

Universal life insurance policies work best for people with large cash reserves and those who are already investing.

Here’s who may most benefit from a universal life policy:

Individuals with more cash reserves: They may have a higher net worth and need an additional investment option in their financial plan. Such a person may have maxed out their IRAs and 401(k)s and would like to invest additional money in a tax-deferred way.
People comfortable with investing: If you’re already comfortable investing in stocks and mutual funds, the idea of inflation outpacing your cash reserves may keep you up at night. UL insurance lets you invest your cash value in more volatile index funds for greater growth.
Followers of the Infinite Banking Concept: With Infinite Banking, you become your own lender. You can grow the universal life insurance policy’s cash value and borrow the funds, choosing whether to pay yourself interest as you pay the loan back. Imagine taking a $150,000 loan from your UL’s cash account to buy a house instead of borrowing from a bank. You’ll cut out the lender, saving time and money on applications and mortgage interest/fees.
Younger individuals with significant medical conditions: Certain genetic or medical conditions will make it more difficult to obtain life insurance in the adult years if the condition develops or worsens with age. Vanessa Coffeen of Farmers Insurance recommends “buying UL insurance for a child or young adult to guarantee they have coverage for a lifetime in the years when premiums are cheaper.”

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

Whole life and universal life are both permanent policies and come with a death benefit and cash value. But whole life insurance is much simpler and premiums are fixed, so you know what to expect. As for the cash value portion, a whole life policy earns a small amount of interest.

When comparing whole life vs. universal life, whole life is like putting money in a savings account and universal life is like investing your money.

Policy benefit	Whole life	Universal life
Permanent coverage	Yes	Yes
Premiums	Fixed	Flexible
Death benefit	Fixed/guaranteed	Flexible/adjustable
Cash value	Nominal interest rate	Based on chosen investment type
Risk of cash value	None	May come with risk
Tax-deferred growth of cash value?	Yes	Yes

Advantages and disadvantages of universal life insurance

Universal life insurance has its pros, but there are also drawbacks. The main universal life insurance pros and cons are:

Pros:

Guaranteed for life as long as you pay your premiums
Premium payment flexibility
You can increase or decrease your death benefit amount without losing coverage, although you may have to pass a new medical exam if you want to significantly increase the death benefit
You can adjust how much you’d like to contribute to the cash value fund
The cash value amount has the potential to earn more than minimal interest if you choose indexed universal life
Cash value grows tax-deferred
You can borrow or make withdrawals throughout your lifetime from your cash value account

Cons:

More complex to understand and manage
The cash balance can fluctuate in value depending on market performance
Your growth is capped, even if the market is doing well
Fixed UL premiums may vary based on interest rates
If you overdraw your cash value, it can decrease the death benefit amount
Gains on your investment will be taxed on withdrawals

Is universal life insurance a good investment?

The main purpose of life insurance is to provide a death benefit to loved ones. Universal life insurance is a better investment than term and whole life because the cash value balance can earn more, but it shouldn’t replace other traditional forms of investments, such as retirement accounts.

Universal insurance comes with fees that eat up part of your premium contribution. And even if you’re investing in an index fund, your growth is capped, regardless of market performance.

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Cynthia Bowman

Contributing Researcher

Cynthia Paez Bowman is a personal finance writer with degrees from American University in International Business and Journalism. Her work has been featured in MSN, Brex, Bankrate, Freshome, The Simple Dollar, GOBankingRates, and more. Cynthia is based between Las Vegas and Europe. In her spare time, she travels throughout Africa and the Middle East helping women entrepreneurs develop and grow their businesses.