To understand what universal life insurance is, we need to discuss the two basic types of life insurance policies.
They are: permanent life insurance, and term life insurance.
Term life works by guaranteeing a set premium amount for a set number of years. So the “term” is not how long the policy lasts — rather, it only means how long your premium payments will remain the same.
That means that a 10 year term policy will guarantee you a set premium amount for 10 years.
So what happens once your term expires?
The premium payment goes up… big time. At this point most people drop the policy because it no longer makes financial sense to keep it (unless it has been converted to a permanent policy).
There is one other important distinction to keep in mind between term and permanent insurance — term policies do not build up a cash value over time.
Universal life insurance policies simplified (hopefully)
Permanent policies, on the other hand, work by guaranteeing a set premium amount for the life of the policy. That means your premium payment will never go up.
Now, here’s where it gets a bit complicated.
There are three basic types of permanent insurance:
- Whole life
- Universal life
- Variable life
So how do these differ?
It all depends on how the cash value builds up over time inside the permanent policy.
For whole life insurance, the cash value accumulates based upon a set percentage rate, sort of like a savings account.
When it comes to universal life, the cash value can build up over time based upon two factors: a guaranteed percentage rate (i.e. “the floor”) and a higher value set to some financial or investment index, such as the S & P 500 (and typically capped to a set percentage of growth, say 10%).
So, that means that the cash value in your policy may increase dramatically in years when the stock market is doing well. And in down years your cash value is protected by the guaranteed percentage gain, say 4%.
Finally, variable life allows you to “invest” the cash inside your policy as if you were investing in mutual funds.
It’s important to note that these policies don’t actually invest in mutual funds, and these types of policies do not typically provide any “floor” for years when the stock market does poorly.
So which policy is right for you?
That really depends on a number of factors, such as:
- the reason for having life insurance (i.e. estate planning, income protection, etc.)
- your retirement goals
- your budget (permanent policies tend to “cost more” for the same “face amount” of insurance versus term insurance)
- and many other personal factors
It’s important to note that there is more to buying a policy than simply getting a quote for a certain amount of coverage. A 1o year term policy doesn’t offer you enough premium protection as a 2o year policy. And permanent insurance does a better job for you when it comes to estate planning.
In the final analysis, it makes sense to speak with an insurance professional when getting an insurance quote.
After all, it’s your money…
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