Universal life insurance combines coverage with savings—but not without trade-offs
It might sound like the best of all worlds: A life insurance policy that lets you adjust how much you pay each month and acts a bit like a savings account. That’s the idea behind universal life insurance, a policy that lasts a lifetime, with features you can tailor to your needs.
But that flexibility comes with trade-offs. A universal life policy can accumulate savings and adjust over time, but as with most things related to your personal finances, it requires some attention to keep things on track. If you stop making payments or rely too heavily on the policy’s cash value to cover the cost of premiums, your coverage could lapse, leaving you without insurance and potentially losing the savings you’ve built.
Key Points
- Universal life insurance provides lifelong coverage, as long as your premiums are paid.
- These policies offer flexible premiums, an adjustable death benefit, and the potential to accumulate savings.
- An indexed-universal life policy is often marketed as an investment, but returns are capped and may lag the stock market.
What is universal life insurance?
Universal life insurance is a permanent policy, which means it stays in effect for the remainder of your lifetime as long as your premiums are paid. There’s no need to renew or worry about the term coming to an end.
Flexibility is what sets universal life insurance apart from other permanent policies. You can adjust how much you pay each month—as long as the policy stays funded—and increase or decrease your death benefit over time. Some policies allow lower initial premiums that fund the policy for 10 or 15 years, while higher payments can keep the coverage in place indefinitely.
Your policy may also accumulate savings, known as cash value. Depending on the policy, those savings might grow at a fixed rate, track a market index, or be invested directly. Some policies even allow you to add the cash value to the death benefit.
How universal life insurance builds cash value
Cash value—accumulated savings that grow within your policy over time—builds gradually from the premiums you pay. Part of each payment goes toward your death benefit, part covers administrative costs, and the rest goes into the cash value portion of your policy. How that savings grows depends on the type of universal life policy you choose:
- Fixed universal life policy. Your cash value earns a guaranteed minimum interest rate, which results in predictable but relatively low growth.
- Indexed-universal life policy. Growth is tied to a market index, such as the S&P 500. These policies usually include a floor that protects you from losses in a down market, but also a cap that limits gains. For instance, if the index returns 10%, your credited interest might be capped at 7%.
- Variable-universal life policy. You choose how the cash value is invested, typically in subaccounts similar to mutual funds. This option offers the most growth potential, but also the greatest risk. If your investments lose money, your cash value could shrink.
Universal life insurance is frequently marketed as a way to invest, especially with indexed or variable policies. But that approach comes with important caveats. If your cash value grows and you want to take money out, you typically have two options: withdraw funds or take out a loan against the policy. Withdrawals may be subject to capital gains taxes if they exceed the amount you’ve paid into the policy. Loans are generally tax free, but your death benefit will be reduced unless you repay it.
Universal life premiums: Minimums, targets, and risks
Many universal life insurance policies offer flexible premiums. You’re required to pay at least a minimum amount, but insurers often recommend a higher payment, or target amount, to help ensure the policy stays in force and builds cash value.
The minimum is usually enough to fund the policy for about 15 years. But if you don’t pay more than that, the policy could lapse when the funding runs out (unless you renew at a much higher cost). What’s more, your cash value may fail to accumulate if you stick with just the minimum.
Cash value to pay your premiums
Once your universal life policy has built enough cash value, it may be able to cover its own premiums. For example, after 10 or 15 years of payments, the accumulated savings in your account could be used to fund future premiums automatically. Using your cash value to cover premiums can reduce or even eliminate the amount you need to pay out of pocket, although growth may slow as a result.
Alternatively, you can pay more than the minimum from the start. Your policy will outline how much is needed to keep it in force for life. If you contribute more than that, you might also build cash value along the way. Contributing even more can help your savings grow faster.
Universal life insurance death benefit
These policies typically allow you to adjust your death benefit. If you need more coverage, you can increase the amount (but your premium will rise). You can also reduce your death benefit, which may lower your premium. Or you can keep paying the same premium to build more cash value.
When signing up for universal life insurance, you’ll often choose between two death benefit options:
- Level benefit. The death benefit stays the same, no matter your cash value. If you die with cash value left in the policy, that amount remains with the insurer. Your beneficiaries receive only the death benefit.
- Increasing benefit. The death benefit includes your cash value, so the total payout grows as your savings do. You can still use your cash value while you’re alive, but any amount left in the account is added to the death benefit when you die.
Pros and cons of a universal life insurance policy
| Pros | Cons |
|---|---|
| Flexible premiums and adjustable death benefit | More expensive than term life |
| Potential for cash value growth | Risk of loss with variable policies |
| Option to borrow against your cash value | Returns may be low or capped |
Pros explained
- Flexible premiums and adjustable death benefit. Universal life offers flexibility in how much you pay and how much coverage you carry. You can adjust your premiums within certain limits and increase or decrease your death benefit based on your changing needs.
- Potential for cash value growth. With variable- and indexed-universal life policy options, you can tie your cash value to market performance. Putting your cash value into investments may lead to higher returns than fixed-interest policies, although results vary. Over time, the accumulated savings could supplement your retirement income or other financial goals.
- Option to borrow against your cash value. You can take out a loan against your cash value, often at a lower interest rate than a bank loan. If used for retirement income, these loans can offer flexibility, but any unpaid balance at the time of your death may reduce the payout your beneficiaries receive.
Cons explained
- More expensive than term life. Universal life insurance policies often come with higher premiums than term life insurance. And to build meaningful cash value, you may need to pay well above the minimum. If you pay too little, the risk of the policy lapsing after 10 to 15 years increases.
- Risk of loss with variable policies. Unlike fixed or indexed universal life, variable-universal life policies provide no downside protection. If your investments perform poorly, your cash value could shrink, and your policy may lapse if there’s too little to cover monthly insurance costs and fees.
- Returns may be limited or capped. Fixed-interest policies offer predictability, but returns are often modest—sometimes lower than what you’d earn in a high-yield savings account. Indexed policies may offer more growth potential, but gains are usually capped. Even when the market performs well, you may not see the full benefit.
The bottom line
Universal life insurance may be a good fit if you want lifelong coverage with a modest death benefit and some flexibility. These policies also build cash value, which you can borrow against or withdraw to support other financial goals. But it’s best viewed as insurance first—not a substitute for investing in a 401(k), individual retirement account (IRA), or other tax-advantaged account. Universal life works best when used for long-term protection, with any savings treated as a bonus rather than a primary strategy.
References
- Variable Life Insurance | investor.gov