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Universal life insurance is a type of permanent life insurance that offers more flexibility than many other policies. It allows you to adjust your premiums and, in some cases, your death benefit as your needs change, while also building cash value over time. That flexibility can make it an attractive option for some people, but it's not the right fit for everyone.ย 

Here's how universal life insurance works and when it may make sense.

Learn more: Best life insurance companies this year

Universal life insurance (IUL) is a type of life insurance policy that lets you adjust the death benefit amount and premiums, with a few caveats that we'll discuss shortly. It's sometimes called adjustable life insurance.ย 

Some key features of universal life insurance include:

You get lifelong coverage. It's a type of permanent life insurance, which means that coverage lasts your entire life until the policy matures, often around age 100.

It builds cash value over time. Part of your premiums go toward the cost of insuring your life, while part of your premiums go toward your insurer's costs. Any money left over from the premium goes into the cash value component, which is similar to a savings account.

Your cash value grows based on interest rates. The amount your cash value earns depends on the type of universal life policy you have and how interest is credited.

You can use the cash value while you're alive. Once your policy has built sufficient cash value, you can use the cash value portion to lower your premiums or even skip a payment. You can also withdraw money or take a policy loan.

You can decrease the death benefit at any time. However, increasing the death benefit usually requires a medical exam.

One of the biggest appeals of universal life insurance is its flexibility. If your income fluctuates or decreases once you retire, you can opt for lower premiums. But if you reduce your premiums too much, you risk underfunding the policy, which means you could need to lower the death benefit or allow the policy to lapse.

Read more: What is life insurance? How it works.

When you buy a universal life insurance policy, your insurer gives you a planned premium (also known as a target premium). This is an estimate of how much you need to pay to keep the policy in force for your entire life, or until age 100.ย 

Each premium payment is divided into three parts:

Cost of insurance: The amount it costs to insure your life and provide a death benefit to your beneficiaries.ย 

Insurer costs: The administrative expenses and other costs associated with managing the policy.ย 

Cash value: The remaining money goes into your policy's cash value account, where it grows at market interest rates, though many insurers provide a minimum rate.

At the beginning of the policy, your planned premium is typically much higher than the cost of insuring your life. The remaining amount goes into the policy's cash value component.

Because your risk of dying grows over time, the cost of insurance usually increases each year. Eventually, the planned premium may not cover the cost of insurance. In that case, the insurer would dip into the cash value to make up the difference. You may need to increase your premium payments to avoid depleting the cash value, which would cause the policy to lapse.

Universal life is appropriate for some people, but before you buy a UL policy, be sure to weigh the advantages and disadvantages:

Pros

Cons

Flexibility: You can adjust your premium or death benefit as your needs change.

Risk: If your policy becomes underfunded, you may need to substantially reduce your death benefit. Or the policy could lapse altogether.

Permanent coverage: As long as you adequately fund the policy and keep it in force, UL insurance covers you for your entire life until the policy matures, usually at a specific age, like 95 or 100.

High premiums: Compared with term life insurance, universal life insurance has substantially higher premiums in the early years. But if you reach advanced age, universal life premiums could be cheaper than you'd pay to renew term insurance.

Cash value growth: Cash value is a built-in savings feature that you can withdraw money from, borrow against, or use to lower your premiums. If interest rates are high, your cash value could grow at a higher rate than it would grow in a traditional whole life policy.

Complexity: Even for financial professionals, universal life policies can be confusing. As the policyholder, you're responsible for monitoring your policy's performance and determining whether you're paying sufficient premiums.

Both universal life insurance and whole life insurance are permanent life insurance policies that build cash value. However, there are several key differences between these types of policies.

Feature

Universal life insurance

Whole life insurance

Coverage

Permanent

Permanent

Premiums

Can often be adjusted

Typically fixed

Death benefit

Can often be adjusted

Typically fixed

Cash value growth

Earns interest based on the policy's crediting method

Guaranteed growth, often with the potential for dividends from participating policies

Policy management

Requires ongoing monitoring to ensure the policy stays adequately funded

Minimal ongoing management once the policy is in force

Best for

Those who expect their income or insurance needs to change over time and are comfortable monitoring their policy

People who want a "set it and forget it" policy with predictable costs

Learn more: Types of life insurance: A complete guide

As a cash-value life insurance policy, universal life has several key features you need to understand.

Like other life insurance policies, universal life insurance pays a death benefit to your beneficiaries when you die, as long as the policy remains in force. In most cases, that payout is income tax-free and bypasses probate, so your beneficiaries receive the money more quickly.

Your beneficiaries can use the proceeds however they choose, whether that's replacing lost income, paying off a mortgage, covering funeral expenses, or helping fund a child's education.

Most universal life policies offer one of two death benefit options:

Level death benefit: Your beneficiaries receive the policy's face value only, regardless of how much cash value you've accumulated. For example, if you own a $250,000 policy with $50,000 in cash value, your beneficiaries would generally receive $250,000.

Increasing (or combined) death benefit: Some policies allow beneficiaries to receive both the death benefit and the accumulated cash value. In the example above, that could mean a $300,000 payout. Because this increases the insurer's potential payout, premiums are typically higher.

The cash value in your universal life policy will grow at a rate that's on par with money market fund interest rates, though most insurers guarantee a minimum interest rate. When interest rates are high, your cash value will grow at a faster rate. However, when interest rates are low, your policy will underperform.

You have several options for using your cash value in a UL policy:

Use it to lower your premiums: Many policyholders use their cash value to reduce their premiums, particularly in retirement.

Borrow from it: You can borrow against the cash value, though you're expected to repay the loan plus interest. An outstanding policy loan will lower your death benefit.

Withdraw it: You can also withdraw from your cash value, though doing so also reduces your death benefit.

Surrender the policy: If you no longer need coverage, you can surrender the policy altogether and receive the policy's cash surrender value. In the first 10 to 15 years of the policy, surrender fees will typically apply.

While cash value withdrawals can reduce your death benefit, having leftover cash value when you die typically won't increase the death benefit. Unless your policy offers an increasing death benefit, unused cash value is typically forfeited to the insurer.

Universal life insurance is sensitive to interest rates. If interest rates drop, your policy will build cash value at a slower rate than your insurer projected at the time you purchased your policy. Though there's normally a guaranteed interest rate, these rates tend to be extremely conservative.

But interest rates aren't the only factor that affects policy performance. If your insurer's mortality costs are higher than it projected or other expenses rise, the company can increase the cost of insurance up to the maximum spelled out in the policy. That means less of your premium goes toward cash value.

Lower interest rates, especially when combined with increased insurance costs, could force you to pay higher premiums or reduce the policy's death benefit. Some policyholders find that their only option is to allow the policy to lapse.

The ability to adjust payments based on your financial situation is a major draw of universal life insurance. Some people choose to overfund their policy by paying more than the target premium early on to accumulate cash value faster. Having more cash value gives you more flexibility to reduce your premium later or skip premiums altogether. These options can be especially appealing in retirement, when your income typically drops.

But paying too little into the policy puts your coverage at risk. Making lower payments can quickly erode your cash value. Eventually, you may need to increase your premium to maintain the policy.

The ability to take loans and withdrawals from the cash value is another advantage of universal life insurance. Some people use their cash value to supplement their retirement income.

Keep in mind, though, that policy loans need to be repaid with interest. If you die with an outstanding policy loan, you'll reduce the policy's death benefit. Likewise, withdrawals will also mean less money for your beneficiaries.

In addition to tax-free death benefits, universal life insurance offers tax-deferred growth. Essentially, that means that as long as money stays within the policy, you won't owe taxes on the gains.

If you take money out of the policy, you won't owe taxes if your withdrawal is less than your cost basis, or what you've paid in premiums. If your withdrawals exceed the cost basis, you'll only owe taxes on the amount that's attributed to earnings. For example, suppose you have $60,000 in cash value, but you've only paid $50,000 in premiums. If you withdrew $55,000, you'd only owe taxes on the $5,000 above your cost basis.

Learn more: Is life insurance taxable? Here's when you might have to pay.

Life insurance riders are optional features you can add to your policy for an additional cost. Some common riders that you can add to a universal life policy include:

No-lapse guarantee rider: Keeps your policy in force even if your cash value is depleted.

Accelerated death benefit rider: Lets you access part of your death benefit while you're still alive if you're diagnosed with a terminal illness.

Accidental death and dismemberment (AD&D rider): Increases the policy's death benefit if you die due to a covered accident.

Child or spouse rider: Provides a small death benefit if your child or spouse dies.

Long-term care rider: Allows you to receive some of your death benefit for long-term care costs.

Waiver of premium rider: Lets you stop paying premiums and keep your policy in force if you become disabled. The policy won't build cash value while payments are paused.

Learn more: The comprehensive guide to life insurance riders

There are several different types of universal life insurance. These types of policies mostly vary in terms of how your cash value will grow.

Indexed universal life (IUL): Indexed universal life insurance ties your cash value growth to the performance of a market index, such as the S&P 500 or the Nasdaq. IUL policies generally have a minimum growth rate; however, most also cap the amount you can earn.ย 

Variable universal life (VUL): Variable universal life insurance lets you invest your cash value in sub-accounts that can include stocks, bonds, or both. These policies have the potential for substantially higher cash value growth. But if the market performs poorly, your cash value could decrease.

Guaranteed universal life insurance: Guaranteed universal life insurance policies guarantee your premiums and death benefit, making them less risky than most universal life policies โ€” but also less flexible. Compared with other types of UL policies, guaranteed policies have minimal cash value growth.

With any type of life insurance, your premiums will vary based on many factors, including your age, health, and the amount of your death benefit. Universal life insurance typically pays a higher death benefit per dollar compared to a traditional whole life insurance policy. However, due to the cash value component and the permanent coverage, it's significantly more expensive than a term policy with a similar death benefit.

Guardian Life estimates that a healthy 40-year-old male can expect to pay $3,100 annually for a UL policy with a $500,000 death benefit. By comparison, premiums on a $500,000 20-year term policy for a nonsmoking 40-year-old man start at about $515 annually.

If you're interested in a UL policy, you'll need to work with a life insurance agent or broker. Very few carriers offer online quotes for universal life policies.

Universal life insurance can be a good option for those who want to leave a death benefit for their loved ones, but who also want flexibility and the ability to build cash value. Assessing your life insurance needs can get complicated, though. Universal life policies are especially complex because you can adjust your premium payments, and your cash value and death benefit aren't guaranteed.

Before you purchase a policy, consider having your life insurance needs evaluated by a fee-only financial planner. You'll need to determine how much coverage you need, as well as whether a universal life policy is right for your situation. Because a fee-only financial planner charges you by the service, you don't need to worry that commissions will sway their recommendation.

Once you've purchased universal life coverage, monitoring the policy's performance is essential. You can request a policy illustration from your insurer every year, which projects the policy's performance under various scenarios. It's worth revisiting your policy's performance every few years with a professional, especially if it's underperforming. You may also want to discuss the implications with a financial planner before you change your premiums or take a policy loan or withdrawal.

Universal life offers a lot of flexibility. But that flexibility comes with risks. Be sure you understand the risks before you buy a policy.

Universal life insurance combines lifelong coverage with a cash value account that earns interest over time. You can often adjust your premium payments and, in some cases, your death benefit, but you'll need to maintain adequate policy coverage to prevent lapsing.

Universal life insurance may be worth it if you're in the market for permanent but flexible coverage that builds cash value. However, it may not be ideal if you're primarily looking for the most affordable life insurance, since term life insurance typically costs much less.

Both build cash value and stay intact as long as you keep your policy in force. But whole life insurance has the same premium payment and earns the same interest rate. UL insurance may allow you to adjust your premium and coverage over time.

If your policy has enough cash value, your insurer may use it to cover your premiums for a period of time. Once that cash value is depleted, however, you'll typically need to resume premium payments, reduce your death benefit, or risk the policy lapsing and your coverage ending.

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