Breaking Down Universal Life Insurance

Hi, my name is Ben Ruttenberg. I’m a wealth advisor with EWA and today we’re going to talk about universal life insurance to a full product breakdown. We’re going to talk about what universal life insurance is and how it’s similar and different to some other types of life insurance that you may have heard of.

We’re going to talk about the different types of universal life insurance and then some issues that we have with universal life insurance and why we typically don’t advise it to be a part of your financial plan. Before we dive into what universal life insurance is, I wanted to give a quick background on the two other main types of life insurance that you may or may not be familiar with.

The first one being term insurance and the second one being whole life or permanent insurance. Term insurance, as the name suggests, is life insurance coverage that lasts for a certain term. This could be 10 years, 20 years, 30 years. If you have it with certain companies, it could be annually renewable to a certain age, like 70 or 80.

It’s the best way to get the most amount of coverage for the least amount of cost. On the other side, there is whole life or permanent insurance. It’s more of a monetary commitment upfront, but in return you have lifelong coverage that does not expire and you also have a cash value component that is correlated with whole life insurance that grows outside of the stock market and can be used to reduce your sequence of return risk when you’re taking distributions from your portfolio in down markets, in retirement, so on and so forth.

With all that being said, universal life insurance has some similarities and some differences to both term and whole life insurance. There is a permanent death benefit associated with universal life insurance as long as premiums are continued to be paid. There’s also a cash value component and the death benefit from a universal life policy is paid income tax free to your beneficiaries.

Where universal life and whole life differ is that whole life insurance, traditional whole life insurance has a fixed premium that you must pay to keep the policy in force. That premium is due either every month, every quarter, every year, depending on how your policy is structured.

Universal life, there is a lot more flexibility in how you can pay. You can either increase premiums or decrease premiums within certain limits. You can skip premiums. There are very, very flexible options with how you can pay a universal life insurance contract and we’ll get into a little bit of how that can be dangerous in a slippery slope if not structured correctly.

There are two types of universal life insurance. There is GUL and IUL. GUL stands for guaranteed universal life and it works very, very similar to a lifelong level term policy. There’s no cash value component to a GUL policy and it is almost if you have taken a level term policy and you have it forever.

In theory, it sounds like a great product. However, it is more expensive than traditional term insurance and the issues that we run into with GUL policies are if there is a missed payment or if there is a lapsed payment, your policy will likely lose its guarantees or even laps.

The issue with that is you will then lose your coverage and there’s no cash value. There’s nothing you’re going to get back from the insurance company in the event of a policy lapse. They will simply just take all the premiums that you have paid and you’ll have nothing to show for it, no coverage and then no cash value.

Indexed universal life is a type of universal life insurance policy that has a cash value component that is credited based on equity performance. However, in all of the IUL policies that we have analyzed between the fees, the expenses and the commissions, those eat into that supposed equity performance and oftentimes the IUL policies are sold and not bought and generally do not have a place in your financial plan.

Some of the main issues that we see with universal life insurance is that when you make a payment to a universal life insurance contract, the first portion of that payment goes to the actual cost of insurance. For example, if you had a loan that you had to pay for, you could have a loan that you a $500 ,000 universal life insurance policy and you made your premium payment, let’s just say in this example, $3 ,000 annually and the cost of insurance was $2 ,000.

So $2 ,000 goes to take care of that $500 ,000 death benefit and the remaining $1 ,000 goes towards your cash value and then the fees and expenses to keep the policy going. So back to the original issue, because universal life insurance has flexible premiums, this $3 ,000 hypothetical premium is not going to be due every year so you can either pay it, choose not to pay it, you can skip payments, you can pay less.

Where this goes bad is that this cost of insurance, the initial $500 ,000 that you took out, that increases every year like an annually renewable term insurance policy. So it’s a very, very slippery slope where the actual cost of your insurance is increasing every year and your premium structure is either staying the same or it’s being skipped or the premiums are decreasing.

There’s no strict premium schedule that you have to follow in a universal life insurance contract. So you can get to a point where you have to make a large payment just to keep the death benefit that you have originally wanted in force or if you chose to surrender the policy and try to take out any cash that is in the policy, that is done at an ordinary income rate which is typically and generally less favorable than a long -term capital gains rate.

So you could be forced with, again, a large premium payment just to keep the policy in force or a large taxable event if you wanted to surrender the policy itself. So for all these reasons we typically advise against universal life insurance as part of your financial plan.

Oftentimes we find that term insurance or whole life insurance or a combination of the two is able to address your insurance needs without having to involve a more complicated product than you may need. So if you have a universal life insurance policy and you have questions about your payment structure or how the policy itself is structured, feel free to reach out.

We’re happy to help.