Universal Life Insurance: What It Is & How It Works


Universal life insurance is a type of permanent life insurance, meaning it lasts for your entire life as long as you keep up with your premium payments. It’s similar to whole life insurance in that it has a cash value component in addition to the death benefit. However, it differs from a whole-life policy because the premiums and death benefit are flexible, and the rate of returns from the cash value isn’t guaranteed.

If you decide to get married or consider having children, it makes sense to start thinking about life insurance coverage. It’s a good way to make sure your loved ones are taken care of financially when you pass away, especially if it’s sudden.

“Life insurance is one of the most important types of coverage to have once you have moved from a ‘me’ to ‘we’ stage of life and want to protect your loved ones,” says Sahang-Hee Hahn, Head of Strategy and Planning at Haven Life. “Ultimately, if the loss of your income is something that would seriously affect your partner or dependents, the best way to ensure their financial security is by purchasing a life insurance policy.”

But there are a lot of life insurance options out there, which can make it difficult to choose which is the right policy for you. Today, we’ll take a look at universal life insurance policies, how they differ from other common types of life insurance, and the different variations of universal life.

What is universal life insurance?

Universal life insurance is a type of permanent life insurance policy that covers you until you die as long as you continue to make your premium payments. A universal life insurance policy is different from term life insurance because term insurance only lasts for a specified period of time — usually 20 or 30 years. Once the term is up, the policy expires.

As mentioned, universal life insurance has some similarities with whole life insurance in that it lasts for your lifetime and has a cash value component. That said, it’s distinctive because it has flexible premiums within certain limits, and the policy’s death benefit can vary as well.

Pro Tip

A good rule of thumb that insurance experts recommend when deciding how much life insurance you need is to calculate five to 10 times your current salary. So if you make $50,000 a year, you should have anywhere between $250,000 to $500,000 worth of life insurance coverage.

How does universal life insurance work?

Unlike term life insurance policies, universal life insurance has a cash value, which means that your policy premiums don’t just pay for the death benefit amount. Instead, there are two components to your premium payments with a universal life policy like there are with other permanent life insurance policies.

One portion of your premium goes toward the cost of insurance (COI), which includes paying for the death benefit coverage and any administrative fees that go along with managing your policy. This is technically the minimum amount you can pay to maintain coverage.

The second part of your premium payment is used to fund the policy’s cash value. The cash value component is much like a savings or money market account that earns interest. It may be tied to a market index or other investments and has the potential to lose money. However, some universal life policies have a minimum interest rate, which gives you some protection from losses.

As the cash value grows, policyholders can withdraw money or access the cash value through policy loans at interest rates that are often lower than many personal loans. Any money withdrawn from the cash value, if not paid back, will be deducted from the death benefit amount. Any money left in the cash value will continue to grow tax-free, but you may have to pay income taxes on some withdrawals

When you die, your beneficiaries receive the death benefit, but the policy’s cash value will revert to the life insurance company. That said, one of the unique features of universal life insurance is that you may be able to increase the death benefit payout based on your accumulated cash value, although you may need to undergo a medical exam first.

Advantages of universal life

Before you purchase universal life insurance (or any insurance), it’s good to know the potential policy benefits and tax implications of this type of insurance.

Potential for cash value growth

Most permanent coverage comes with a cash value component, which can be useful on many levels, depending on your overall financial situation. You can withdraw cash or take out policy loans and use it to supplement your retirement income, pay for your child’s college education, finance a wedding, or pay off high-interest debt.

You can also use the cash value to pay some or all of your policy premiums if you have enough in your cash value account to cover it.

Flexible premiums

In most cases, like with term life insurance and whole life coverage, you pay premiums that are fixed throughout the duration of the policy. Universal life insurance, on the other hand, gives you some flexibility on how much you pay each month. However, it’s important to note that insurance companies will set certain limits on how much you can raise or lower your premiums.

For example, as you get older you may have to pay higher premiums for universal life insurance because premiums are often tied to the age of the policyholder. But, if you have enough cash value, you may be able to actually lower your out-of-pocket premiums because the cash value can be used to cover part (or sometimes all) of the policy premiums.

Flexible death benefit

Universal life insurance can also offer a flexible death benefit. For example, if you no longer need as much insurance coverage (say your kids are grown), you may be able to lower the death benefit and also pay reduced premium payments.

You can also sometimes increase the death benefit, based on your policy’s cash value, although you may need to get a new medical exam.

Tax-free growth

Much like your employer-sponsored 401(k) or an individual retirement account (IRA), the cash value of your universal life policy will grow tax-free. And if you take out a loan against the policy, there are no tax consequences. You only have to pay income taxes on the money if you make certain types of withdrawals.

IMPORTANT! If you have an outstanding loan at the time of your death, that money will be deducted from the death benefit amount that your beneficiaries receive.

Disadvantages of a universal life insurance policy

It’s also important to be aware of the possible risks and drawbacks of universal life insurance.

Loss of cash value upon death

As previously mentioned, if there is cash value left over at the time of your death, that money will be absorbed by the issuing insurance company. This means your beneficiaries will only inherit the death benefit, but none of the remaining cash value.

There are a few ways around this, however. For instance, you could use the cash value to raise the death benefit, use it to pay for your policy premiums, or make withdrawals (which may be taxed as income).

Or, if you no longer need the death benefit, you can sometimes sell or surrender the policy and liquidate the cash value. That said, you may have to pay a surrender fee depending on your policy terms.

Cash value growth not guaranteed

The cash value of insurance is an investment of sorts and, as such, comes with some risks. For example, if interest rates go down, your cash value portion may not perform very well.

Unlike other types of permanent life policies, universal life doesn’t always guarantee your money will grow (although some do come with a minimum interest rate).

Risk of higher premium payments

While one of the benefits of universal insurance is flexible premiums, sometimes they can get higher than expected (especially as you age), which might be difficult to budget for. This is particularly true if your cash value has underperformed.

You’ll want to keep a close eye on the cash value account because if it falls to zero and your premiums don’t cover the cost of insurance, your policy could lapse.

Some withdrawals taxed

Oftentimes with life insurance, you can only withdraw cash up to what you’ve contributed without having to pay income taxes on the money. So if you need to withdraw more than that, you’ll be on the hook for taxes.

If that’s the case, you might be better off taking a low-interest policy loan instead. That could reduce the death benefit if you don’t pay it back, but it could be the smarter move depending on your financial situation.


Here is a list of the benefits and drawbacks to consider.

  • Flexible premiums
  • Flexible death benefit
  • Potential for cash value growth
  • Cash values grow tax-free
  • Policy loans
  • Cash value growth not guaranteed
  • Income taxes on some policy withdrawals
  • Risk of higher premium payments as you age
  • Risk of the policy lapsing if you don’t have enough cash value
  • Cash values of life insurance policies are forfeited to the insurance company upon death

To get a better idea of what’s included in a life insurance policy, take a look at some of the policies below.

Types of universal life policies

Depending on the insurance company you contract with, there are a few different variations of universal life insurance you can choose from.

Indexed universal life insurance

With indexed universal life insurance, your cash value growth (or loss) is tied to a market index such as the S&P 500. This could give you potentially higher growth than guaranteed universal life, but it’s a little riskier.

Plus, your insurance company may cap your rate of return, which can limit your gains when the market is performing well. With indexed universal life insurance, you may also have the option to put some or all of your cash value into a fixed-rate account. That’s a safer move but won’t realize very big returns.

Variable universal life insurance

Variable universal life is the riskiest type of universal life insurance because the policy’s cash value is tied to investments you choose, such as stocks, bonds, and mutual funds. On the other hand, you have the potential to build more cash value with variable universal life than other types of universal life insurance.

Guaranteed universal life insurance

Guaranteed universal life insurance, also known as “no-lapse” guaranteed universal life, is generally less expensive than other life policies and comes with fixed premium payments and a guaranteed death benefit. The cash value is very limited on this type of universal life insurance policy, but that may work for some people, says Matt Schmidt, CEO of Diabetes Life Solutions.

“Guaranteed universal life insurance is oftentimes the lowest cost form of permanent life insurance. Premiums will be less expensive compared to whole life insurance as an example. While these products are not suitable for everyone, they can be a perfect type of policy for individuals needing life insurance for a longer period of time,” says Schmidt.

Pro Tip

As with any type of insurance, get more than one universal life insurance quote and be sure you understand the details of the policy. Universal life insurance policies can be complex, so it’s always a smart move to also talk to a trusted financial advisor or experienced insurance agent first.


Which is better: whole life or universal life?

If you like the predictability of fixed premiums, a guaranteed death benefit, and better potential to grow your cash value, whole life insurance might be a good choice for you. However, keep in mind that it does tend to be more expensive than universal life policies.

If you prefer the idea of flexible premium payments and an adjustable death benefit, then a universal life insurance policy might be a better fit.

Is a universal life policy a good investment?

While some life insurance policies have an investment component that can be useful, it’s really secondary to the death benefit, explains Jiten Puri, CEO at PolicyAdvisor.com.

“Generally speaking, life insurance is not the strongest investment strategy on its own. The benefit comes from the policy itself, and the death benefit provided to loved ones after the policyholder has passed away.”

Key Takeaways

  • Unlike most types of life policies, universal life insurance offers flexible premiums and adjustable death benefits.
  • Part of your monthly premium goes toward paying the cost of insurance and the rest is used to build the policy’s cash value component.
  • As you build cash value, you have the opportunity to withdraw money from the universal life policy or access the money through policy loans.
  • Depending on the type of universal life insurance you have, you’ll need to keep an eye on the cash value portion of your policy to ensure you have enough cash value so your policy doesn’t lapse.
  • Variations of universal life insurance include guaranteed universal, indexed universal, and variable universal life insurance.
View Article Sources
  1. Life Insurance — National Association of Insurance Commissioners
  2. Tax Treatment of Life Insurance and Annuity Accrued Interest — United States General Accounting Office
  3. Life Insurance & Disability Insurance Proceeds — IRS
  4. What Is Indexed Universal Life Insurance (IUL)? — SuperMoney
  5. I Need Life Insurance. What Kind of Life Insurance Should I Buy? — SuperMoney
  6. What Does Life Insurance Cover? — SuperMoney
  7. The Differences Between Whole and Term Life Insurance — SuperMoney
  8. What Are The Different Types of Life Insurance? — SuperMoney
  9. Guaranteed Life Insurance: Should You Buy It? Pros and Cons — SuperMoney
  10. What is Term Life Insurance? And Why Is Everyone Suddenly Interested — SuperMoney
  11. Best Life Insurance — SuperMoney
  12. Best Term Life Insurance — SuperMoney
  13. Ladder — SuperMoney
  14. Everyday Life Insurance — SuperMoney