Universal Life Insurance
What it is:
How it works/Example:
Universal life insurance is based on whole life insurance. Whole life insurance policies comprise both an insurance and a savings component. The policyholder pays a fixed premium for life. Part of this premium builds up the insurance benefit, while the rest is invested in the savings account. The savings account serves as a tax-deferred resource from which the policyholder may withdraw funds or against which he may take out a loan (in accordance with the terms of the policy). In the event of death, the beneficiary on the policy is awarded the value of the savings account in addition to the accrued death benefit.
Similar to whole life insurance, universal life insurance offers the policyholder greater flexibility with regard to premium, payment, and use of savings and insurance benefits. Unlike whole life insurance, universal life insurance premiums and savings interest rates are variable from month to month. For this reason, universal life policyholders have the option to pay their premiums (in whole or in part) using interest from the associated savings account. However, fluctuations in interest rates and policy premiums pose a risk to policyholders not present in basic whole life insurance. In addition, policyholders, based on their life circumstances, may modify their policies between how the premium amount is allocated between the insurance benefit and savings account. As a result, universal life insurance provides more transparency concerning how the plan is managed as well as the investments that comprise the savings account
Why it matters:
Universal life insurance allows the policyholder to tailor the policy to his individual circumstances to provide the greatest benefit at any stage in life. However, universal life insurance policies do carry higher risk with regard to fluctuations in insurance premiums and interest rates.