Switching a universal life death benefit option: a worked example

Say Taylor, 50, owns a universal life policy with a $500,000 level death benefit and $100,000 in the account. Taylor's family situation has changed, and Taylor wants to know whether switching to an increasing death benefit would be worth doing, and what the insurer would ask along the way. This walkthrough follows that change from the first question to the first statement afterward, with the arithmetic shown at each stage.

The numbers are invented round figures chosen to make the mechanics visible. Real insurers differ in their rules, rates and forms, so the policy contract and a written answer from the insurer are what count. The choice between the two options, in general terms, is covered in Universal life death benefit options A and B. This article is about doing the switch.

The switch, step by step

Step 0: Be clear on what the two options pay

Under a level death benefit (option A), the policy pays the face amount. Taylor's $500,000 includes the account value; as the account grows, the part of the $500,000 that is the insurer's risk shrinks. Under an increasing death benefit (option B), the policy pays the face amount plus the account value. With $100,000 in the account, that is $600,000.

The key quantity is the net amount at risk, the part of the death benefit that the insurer is on the hook for beyond the account. The monthly cost of insurance charge is calculated on it. Under option A, it is the face amount minus the account. Under option B, it is the face amount. That one difference drives everything that follows.

Step 1: Work out what the switch does to the monthly cost

Assume the insurer's monthly cost-of-insurance rate at Taylor's age is $0.25 per $1,000 of net amount at risk (an illustration, not a price).

Switching A to B raises the monthly charge by $25, or $300 a year, and raises the death benefit by $100,000. In a policy where the account is not growing, that is a modest difference.

Step 2: See how the gap widens with time

The gap between the options is bigger later, because the account is larger and the rate is higher. Take Taylor at 60. Say the account has grown to $200,000 and the rate has risen to $0.60 per $1,000 per month.

At 60 the difference is $120 a month, or $1,440 a year, in return for $200,000 more death benefit. Notice what happened to option A's charge: the account grew, so the net amount at risk fell from $400,000 to $300,000, and the charge rose only because the rate per $1,000 rose. Under option B, the net amount at risk stayed at $500,000, so the charge rose by the full effect of the rate.

Over a long stretch, the monthly gap is paid out of the account, which means option B's account grows more slowly. That is the trade: a bigger death benefit and a slower-growing account.

Step 3: Decide the direction and the reason

The reason for switching often decides how easy it will be.

• A to B: a reason to want more death benefit. For example, Taylor now wants the account value to pass to heirs on top of the face amount, or a new financial dependent has arrived. The insurer takes on more risk, so it often asks for proof of health.
• B to A: a reason to cut cost or build cash faster. For example, Taylor is in retirement, the premium has become a strain, or Taylor wants the account to grow faster for later withdrawals or loans. The insurer's risk falls, so the change is usually simpler.

Write the reason down. It tells you what to compare, and it guards against switching just because someone suggested it.

Step 4: Ask for an in-force illustration of both options

Request an how to request and read an in-force illustration showing the policy as it is, and another showing it after the switch, at the same premium and the same assumed crediting rate. Ask for the guaranteed column too. Ask for projections at the current assumptions and at a lower rate.

Compare four things:

1. The year each version of the policy runs out of money at the current premium, if it does.
2. The cash surrender value at ages 60, 70 and 80.
3. The death benefit at the same ages.
4. The premium needed to keep the policy going to a stated age.

If the B version shows the policy ending earlier at the current premium, then adding the cost of the switch to your budget is part of the decision.

Step 5: Learn the insurer's rules for this switch

Ask these questions and get the answers in writing.

1. Can this change be made, and from when? Many contracts apply a change at the next monthly deduction date, others at the next policy anniversary.
2. Does the insurer require evidence of insurability? For A to B, expect yes in many contracts, since the amount at risk rises. That can mean a health questionnaire and sometimes an exam. If Taylor's health has declined since issue, the insurer may refuse the change or charge more for it. Taylor keeps the existing policy either way.
3. What happens to the face amount on the switch? This is the detail that most often surprises people. See below.
4. Is there a fee or a surrender charge? Most do not charge for a switch alone, but changes that reduce the face may trigger one.
5. Does it affect any guarantee? A change in option can alter or void a no-lapse guarantee; see mistakes that void a no-lapse guarantee on universal life coverage for how those guarantees break.
6. Does it affect the tax status of the policy? Ask the insurer to confirm it will remain life insurance under the tax rules and not become a modified endowment contract.

What happens to the face amount

Contracts handle the switch in different ways. Taking Taylor's numbers, consider B to A: the policy currently pays $600,000.

• Method 1: keep the total the same. The new level face amount is set to $600,000. The death benefit is unchanged on the day of the switch. The net amount at risk is $600,000 minus $100,000, which is $500,000, the same as before. The monthly cost does not fall at first. It falls later as the account grows, because the level benefit absorbs the growth.
• Method 2: keep the face amount the same. The new level face remains $500,000. The death benefit drops from $600,000 to $500,000. The net amount at risk becomes $400,000, so the monthly cost falls immediately: at $0.25 per $1,000, from $125 to $100.

Which one applies is in the contract or the insurer's administrative rules. For A to B, there are similar choices:

• Method 1: keep the face amount. The total benefit rises from $500,000 to $600,000, and the amount at risk rises with it. This is the one that usually requires underwriting.
• Method 2: keep the total. The face amount is reduced to $400,000, so the total stays at $500,000 ($400,000 plus the $100,000 account). The amount at risk stays at $400,000 and the cost does not change at first. The death benefit then grows from there as the account grows. This version may need no underwriting, because the insurer's day-one risk is unchanged.

Method 2 on A to B is sometimes the cleanest way to get a rising benefit without proving health, if the insurer offers it. Ask.

Step 6: Check the tax-law constraints

A universal life policy must stay within the definition of life insurance in section 7702. Two features are relevant here.

The corridor, which requires that the death benefit exceed the account value by a minimum percentage, can lift an option A death benefit in heavily funded policies, making it behave like option B later in life. The corridor glossary entry has the details. That means that in some policies the practical difference between the options narrows as the account grows.

The modified endowment contract (MEC) test can be affected by a reduction in death benefit within the first seven years of a policy, or after a material change. A policy that becomes a MEC has loans and withdrawals taxed gains-first, with a possible 10% additional tax before age 59½. See modified endowment contracts and the 7-pay test. Because Taylor's policy is established, this is less likely to be a concern, but the insurer should confirm in writing that the change will not cause one. A tax professional can speak to Taylor's circumstances.

Step 7: Complete the paperwork and confirm the date

The insurer will send a change form. Read it before signing, in particular for the effective date, the resulting face amount and total death benefit, the new monthly cost and any statement about guarantees. If underwriting is required, the change takes effect only after approval. Do not assume it is effective on the day you sign. Keep paying premiums as usual in the meantime.

If the insurer declines the A to B request, the original policy continues unchanged. A decline is not a cancellation.

Step 8: Verify on the first statement afterward

After the change, check the next statement against the written answers from step 5.

1. Death benefit and option shown are as stated.
2. Face amount is as expected.
3. Monthly cost of insurance equals the net amount at risk times the rate (for Taylor's A to B, 0.25 × 500 = $125 under the example).
4. Any guarantee still shows as active.
5. The projected end date matches the illustration you were given.

Run the arithmetic once. If the statement shows a charge you cannot reproduce, ask for the breakdown.

Putting numbers on the decision

Here is how Taylor might summarize the result at age 50, using the first table.

• Switching A to B costs $25 a month more now, rising to $120 a month more at 60 in the example, in return for $100,000 now and $200,000 more at 60.
• The cash account grows more slowly under B, because more of each month's premium goes to insurance.
• If the goal is a bigger inheritance and Taylor can afford the higher charge, B may fit. If the goal is to build cash for retirement loans, A fits better, and Taylor might consider switching B to A later.

Neither is the right answer for everyone. What is wrong is making the switch without the in-force illustrations and the insurer's written answers.

Four common slips

People who make this change tend to trip in the same places.

1. Switching without comparing the same premium. An illustration for option A at one premium and option B at another proves nothing. Hold the premium and the assumed rate constant and change only the option.
2. Assuming the death benefit is the same on the day of the switch. As shown above, some contracts change the face amount, so the payout the day after can differ from what you expected.
3. Forgetting an outstanding loan. A policy loan and its accumulated interest are subtracted from the death benefit under either option, and a loan also reduces the account that drives the amount at risk. Run the illustration with the loan included.
4. Ignoring the guarantee. If the policy has a no-lapse guarantee, a change of option can alter the required premium or end the guarantee, as the related article on that subject explains. Get the answer before you sign, not after.

A short decision list

Use these as prompts, not rules.

• If the main goal is the largest possible payout to heirs and the higher charge is comfortable, an increasing benefit is worth pricing out.
• If the main goal is to build cash value for later withdrawals or loans, or to keep the premium needed down, the level benefit usually fits better.
• If health has declined since the policy was issued, a change that raises the insurer's risk may be declined; ask for the version that keeps the total benefit constant.
• If the policy is close to the edge of lapsing, a switch from B to A, or a smaller face amount, lowers the monthly charge and may buy years; see the general guide to how universal life insurance works for why charges drive the outcome.

Other kinds of universal life

The same choice appears in indexed and variable universal life. In an indexed policy, the account value moves with index credits within the cap, and the account growth that drives the gap between options is less predictable. In a variable policy, a market fall lowers the account, which lowers the option B death benefit and keeps the amount at risk from falling as it would under option A. The monthly mechanics of a universal life policy, including where each deduction comes from, are laid out in one month inside a universal life policy: every deduction in order.

Key takeaways

• The two options differ in the net amount at risk: under option A it falls as the account grows, under option B it stays near the face amount, and the monthly cost follows.
• In the example, option B costs $25 a month more at 50 and $120 a month more at 60, in return for $100,000 and then $200,000 more death benefit.
• Switching from A to B usually raises the insurer's risk and may require proof of health; switching from B to A is usually simpler.
• Ask whether the switch keeps the face amount or the total death benefit constant, because the monthly cost and the payout depend on it.
• Get the effect on guarantees and tax status in writing, then check the first statement afterward against what you were told.