Universal life insurance lets you adjust your premiums and death benefit after you buy the policy, unlike term or whole life where those amounts are locked in

Universal life insurance (UL) is a permanent policy that builds cash value over time, similar to whole life insurance. The difference is flexibility: you can raise or lower your death benefit, skip premium payments in some years, or change how much you pay each month — as long as there is enough cash value in the account to cover the cost of insurance. The insurance company charges you a monthly cost of insurance based on your age and health, invests the rest of your premium payment, and that investment grows tax-deferred inside the policy.

The trade-off for this flexibility is complexity. Your policy value depends on how well the insurance company's investments perform, and if those returns are lower than expected, your premiums may need to go up or your death benefit may go down to keep the policy in force. With whole life, the insurance company absorbs that investment risk. With UL, you do.

Key Takeaways

  • Universal life insurance charges a separate monthly cost of insurance and invests the remainder of your premium in an account that grows tax-deferred.
  • You can adjust your death benefit and premium payments after purchase, but only if the cash value in the policy is large enough to cover the cost of insurance.
  • If the policy's investments underperform, the insurance company may notify you that premiums need to increase or the death benefit will decrease to keep the policy active.
  • Universal life is less expensive than whole life in the early years but requires more monitoring and carries more risk that the policy will lapse if cash value runs out.

How the cash value account works

When you pay a universal life premium, the insurance company deducts the monthly cost of insurance first. That cost is based on your age, health, and the death benefit amount you chose. The remainder of your payment goes into a cash value account that earns interest or is invested in sub-accounts you select.

The cash value grows tax-deferred, meaning you do not pay income tax on the earnings while the money sits in the policy. You can borrow against the cash value during your lifetime, and any loan balance reduces the death benefit your beneficiaries receive. If you surrender the policy (cancel it), you receive the cash value minus any surrender charges, which are highest in the first few years and decline over time.

Adjusting your death benefit and premiums

Universal life policies give you the option to increase or decrease your death benefit after you buy the policy. Increasing the benefit usually requires a new health exam and approval from the insurance company. Decreasing it is simpler and does not require approval, though it may trigger a surrender charge if you decrease it significantly.

You can also change how much you pay each month. You might pay more in years when you have extra income, which builds cash value faster and reduces the risk that the policy will lapse. Or you might pay less in a tight year, as long as the cash value is large enough to cover the cost of insurance for that month. If you skip payments and the cash value runs out, the policy terminates and you lose the death benefit.

Interest rates and investment options

Universal life policies come in two main types: fixed-rate UL and variable UL. With fixed-rate UL, the insurance company credits a set interest rate to your cash value each year, usually between 2% and 4%, though the rate can change. The insurance company guarantees a minimum rate, often 1% or 2%, so your cash value will not decline even if interest rates fall.

Variable UL lets you direct your cash value into sub-accounts that work like mutual funds — you choose how much goes into stocks, bonds, money market funds, or other investments. Your returns depend on how those investments perform. If markets rise, your cash value grows faster and your premiums may stay lower. If markets fall, your cash value shrinks and you may need to pay higher premiums to keep the policy in force.

When premiums may increase or the policy may lapse

The insurance company sends you an annual statement showing your cash value, the cost of insurance that year, and how much premium you need to pay to keep the policy active. If investment returns are lower than the insurance company projected when you bought the policy, or if you are older and the cost of insurance has risen, the required premium may go up.

If you cannot or do not pay the higher premium and your cash value is not large enough to cover the cost of insurance, the policy will lapse. Once it lapses, you lose the death benefit and cannot reinstate it without a new health exam and approval. This is the biggest risk of universal life: a policy that seemed affordable at age 40 may become unaffordable at age 60 if the cash value has not grown as expected.

Universal life versus whole life versus term life

Term life insurance is the cheapest option and covers you for a set number of years (10, 20, or 30 years). It has no cash value and no flexibility — you pay the same premium every month for the term, and when the term ends, the coverage ends. Term is best if you need coverage for a specific period, like until your mortgage is paid off or your children are grown.

Whole life insurance is more expensive than universal life in the early years but offers more certainty. Your premium and death benefit are locked in for life, and the insurance company guarantees the cash value will grow at a minimum rate. You do not have to worry about the policy lapsing or premiums increasing. Whole life is best if you want permanent coverage and do not want to monitor the policy.

Universal life falls in the middle. It costs less than whole life initially because the insurance company does not may provide the cash value growth. You get flexibility to adjust premiums and benefits, but you also take on the risk that the policy will not perform as expected. Universal life is best if you want permanent coverage, think you may need to adjust your death benefit or premiums later, and are willing to review your policy annually.

Frequently Asked Questions

Can I stop paying premiums on a universal life policy?

You can skip or reduce premium payments as long as the cash value is large enough to cover the monthly cost of insurance. Once the cash value runs out, the policy lapses and you lose the death benefit. You cannot reinstate it without a new health exam.

What happens if I borrow money from my universal life policy?

You can borrow against the cash value at any time, usually at a rate set by the insurance company. The loan balance reduces the death benefit your beneficiaries receive, and you may owe income tax on the loan if the policy lapses while you still owe money.

Is universal life a good investment?

Universal life is insurance first and an investment second. The cash value growth is usually modest compared to investing the same money in a taxable account. Universal life is best for people who want permanent death benefit coverage and are willing to pay for that benefit through the policy's cost of insurance.

What is a no-lapse may provide on a universal life policy?

Some universal life policies include a no-lapse may provide that keeps the policy in force as long as you pay a specified premium, even if the cash value drops to zero. This removes the risk that the policy will lapse unexpectedly, but the may provide premium is usually higher than the initial premium.