Universal life (also referred to as UL) is a type of permanent death benefit that allows for premium flexibility over time. Initially there is a minimum premium required but as the policy develops cash value an owner can choose to pay less than the minimum. Paying only the minimum premium or less will often result in the policy needing additional premium down the road or risk lapse (ending for non-payment of premiums) prior than anticipated or desired. Many policy owners choose to pay more than the minimum premium to build cash value (equity) in the policy. Once enough equity has been developed, the internal interest generated can pay the policy costs thus reducing or eliminating out of pocket premium payments.
Universal life offers two common methods of tax-deferred interest crediting – fixed or indexed. Fixed interest is a stated rate that can fluctuate subject to a guaranteed minimum. Indexed interest is a stated rate calculated by a formula that pays more in years where a stock market index goes up, and zero in years where an index goes down. Index interest crediting policies do not participate in the stock market and never decrease the cash value when an index goes down. Due to their ability to avoid negative crediting in years when an index goes down, it is feasible for index crediting policies to generate an average interest rate that is higher than a traditional fixed interest rate UL over time, although that result is not guaranteed. Both types of Universal life interest rates will fluctuate and it is prudent to consider conservative interest assumptions when looking at future projections.
Universal life allows for cash withdrawals and loans, both of which can be used for emergencies or potentially as a source of future tax-free income. Loans from index policies can continue to earn the potentially larger index interest crediting which is something most other types of permanent life insurance policies cannot offer. Some UL’s have more favorable loan terms than others, where the loan interest is fully credited to the policy cash value allowing the owner to pay themselves interest instead of paying it to a lender. This makes the policy value beneficial and can allow an owner to act as their own lending institution for personal or business needs.