Guides
How universal life insurance works
Universal life splits a permanent policy into a cash account and monthly charges. See how premiums, interest, costs and death benefit options fit together.
Universal life is permanent life insurance with a visible cash account and flexible premiums. Each month the insurer takes the cost of the insurance and its fees out of the account, and credits the balance with interest. The policy lasts for life only if the account stays large enough to pay those charges, so how much you put in, and how the insurer's assumptions turn out, decide whether it does.
The three moving parts
A universal life policy "unbundles" what a whole life policy bundles together. You can see three separate pieces:
- The account (cash value). Premiums, minus any premium load, go into an account. This is your cash value. It earns interest at a declared crediting rate.
- The monthly deductions. Every month the insurer subtracts the cost of insurance (COI), an administrative fee, any per-thousand-dollar expense charge, and the charge for each rider. The COI is the price of the insurer's risk, based on your age, sex, rate class and the "amount at risk," which is the death benefit minus the account.
- The death benefit. Your beneficiary receives the face amount (plus the account, under one option), income-tax-free in most cases. See is life insurance taxable?.
Because the COI rises with age, the monthly deduction is small when you are 35 and large when you are 85. The account has to grow, or be topped up, to keep paying it.
What flexible premium means
Unlike whole life, you are not required to pay a fixed premium. The insurer sets a planned premium and you can pay more, less, or skip a payment, as long as the account can cover that month's deductions. The policy lapses only when the account cannot, and then the insurer must give a grace period (the statutory minimum varies by state; see life insurance grace periods and lapses).
Flexibility cuts both ways. Paying only a low planned premium for decades can leave a policy that looks fine at 50 and runs out of money at 80. why universal life policies lapse, and how to prevent it explains how to spot and avoid that.
Guaranteed and current assumptions
Every universal life policy has two sets of numbers, and the gap between them is what you are really buying:
- Guaranteed values use the maximum COI and administrative charges stated in the contract and the minimum interest rate (the guaranteed interest rate), often a low figure such as 2% to 4% depending on when the policy was issued.
- Current values use what the insurer charges and credits today. These are non-guaranteed elements. The insurer can change them, within the guaranteed limits, as its costs and investment returns change.
A sales illustration normally shows the current assumptions. Ask to see the guaranteed column too. guaranteed vs non-guaranteed values in a policy illustration and how to read a life insurance illustration show how. Insurers have raised COI rates on in-force policies in recent years, which has led to litigation; see universal life cost-of-insurance increases and what to do.
Death benefit options
Most policies offer two choices, described in detail in Universal life death benefit options A and B:
- Option A (level). The death benefit stays at the face amount. As the account grows, the amount at risk shrinks, so the COI charge falls.
- Option B (increasing). The death benefit is the face amount plus the account value. Premiums are higher because the amount at risk stays constant, but the benefit grows with the account.
Federal tax law (section 7702) requires that the death benefit exceed the account by a minimum margin, called the corridor, for the policy to keep its life insurance tax treatment.
A hypothetical walk-through
Say a 40-year-old nonsmoker buys a policy with a $500,000 face amount (Option A) and pays $300 a month. This is an invented example, not a price.
- Early on, the insurer takes a premium load and monthly deductions, and the remainder earns interest in the account.
- Over time the account builds. If the credited rate is higher than assumed, the account grows faster and the policy may be able to carry itself on smaller payments.
- If the credited rate falls, or the insurer raises its COI, the same $300 may no longer be enough. The annual statement shows the account and projected lapse date; at some point the owner must pay more or accept less coverage.
Nothing in this example is guaranteed unless the policy's guaranteed column shows it.
Taxes, loans and surrender
Cash value grows tax-deferred. You can take a loan against it or make withdrawals (see life insurance policy loans: how they work and what they risk and withdrawing cash value from a life insurance policy); loans reduce the death benefit and accrue interest, and a loan outstanding at lapse can trigger a tax bill. how cash value is taxed: withdrawals, loans and surrenders covers the rules. If you pay premiums faster than federal limits allow, the policy becomes a modified endowment contracts and the 7-pay test and loan taxation changes.
Most policies carry a surrender charge for the first 10 to 15 years, so canceling early often returns much less than you paid. See surrendering a life insurance policy: what you get and what it costs.
The universal life family
| Variant | How the account is credited | Guarantee level |
|---|---|---|
| Current-assumption UL | Declared interest rate | Minimum rate |
| Guaranteed UL | Little or no cash value | Death benefit guaranteed to a set age |
| Indexed UL | Linked to an index with a cap and floor | Floor, often 0% |
| Variable UL | Invested in subaccounts | Almost none |
Details: current-assumption universal life and crediting rates, guaranteed universal life: permanent coverage without the cash, Indexed universal life (IUL) explained, Variable universal life (VUL) insurance.
Who it suits
Universal life can suit someone who wants lifelong coverage but expects irregular income, or who wants to adjust the death benefit later. It suits people less well if they will not review the policy every year, cannot afford to fund it above the minimum, or want a firm guarantee; whole life and guaranteed universal life offer more certainty. Compare with whole life vs universal life and use the which type of life insurance fits me?.
Key takeaways
- Universal life has a cash account, monthly charges for insurance and fees, and flexible premiums.
- The policy lapses when the account cannot cover the monthly deductions, and cost of insurance rises with age.
- Illustrations usually show current, non-guaranteed assumptions; always ask for the guaranteed column.
- Check an in-force illustration every year or two and fund above the minimum if coverage must last for life.