5 Things to Know Before Buying a Universal Life Insurance Policy

5 Things to Know Before Buying a Universal Life Insurance Policy

Universal Life (UL) insurance is often marketed as a flexible, permanent life insurance solution that combines a death benefit with a cash value savings component. Its promise of adjustable premiums and the potential for cash accumulation can be alluring. However, UL is one of the most complex financial products available, and misunderstanding its mechanics can lead to costly surprises. Before you purchase a policy, here are five critical things you must understand.

1. It's Not a Savings Account; It's a Performance-Dependent Contract

Many people view the cash value component of a UL policy as a simple savings or investment account. This is a dangerous misconception. A UL policy is an insurance contract where your premiums (after hefty fees and the cost of insurance) are credited with interest. The insurance company sets a minimum guaranteed interest rate (often quite low, like 2-3%) and a current interest rate (which is not guaranteed).

The growth of your cash value is entirely dependent on this current rate, which is tied to market benchmarks. If the insurer's portfolio performance drops, so can your credited interest. Unlike whole life, there is no guaranteed dividend. Your policy's longevity and its ability to sustain itself rely heavily on these interest credits meeting the projections shown in your initial illustration.

2. The Devil is in the Details: Understand the Costs & Charges

UL policies come with a labyrinth of fees that can significantly erode your cash value, especially in the early years. Key charges include:

• Premium Load: A percentage of your premium taken off the top before money goes to cash value.
• Cost of Insurance (COI): The actual price for the death benefit protection. This charge increases every year as you age.
• Policy Fees: Flat monthly or annual administrative fees.
• Surrender Charges: Heavy penalties for canceling the policy or withdrawing large sums of cash value in the first 10-15 years.

Always ask for a detailed schedule of fees and review the illustration's guaranteed columns, which show what happens if only the minimum interest is credited and maximum costs are charged.

3. Premium Flexibility is a Double-Edged Sword

A major selling point of UL is the ability to adjust your premium payments—you can pay more, less, or sometimes even skip payments if your cash value is sufficient to cover the costs. This flexibility, however, requires active management and understanding.

If you consistently pay only the "target" or "suggested" premium, the policy may perform as projected. If you pay the lower "minimum" premium, you are essentially betting that future interest rates will be high enough to cover the rising cost of insurance. This is a risky gamble. In a prolonged low-interest-rate environment, a policy funded with minimum premiums can deplete its cash value and lapse, leaving you with no coverage and a potential tax bill on any gains. Flexibility demands discipline and regular policy reviews.

4. Interest Rate and Mortality Risk Are on You

With a UL policy, you, the policyholder, assume two significant risks that the insurance company traditionally bore with older products like whole life:

1. Interest Rate Risk: As mentioned, your cash value growth is not locked in. If the insurer's current interest rate falls below initial projections for a long period, your policy can underperform dramatically.
2. Mortality Risk: The Cost of Insurance (COI) rates are based on the insurer's mortality experience. If the company's claims are higher than expected, it can increase the COI charges (up to a maximum stated in the contract), further straining your policy's cash value.

You must monitor your policy's performance against these risks, as the insurer is not obligated to keep it in force if the cash value runs out.

5. It's a Long-Term Commitment Requiring Regular Reviews

Buying a UL policy is not a "set it and forget it" purchase. It is a long-term financial instrument that requires ongoing stewardship. You should review your policy illustration at least every two to three years with your financial advisor or agent. Compare the current cash value and projected values to the original illustration.

Ask for an "in-force" illustration that uses the current interest rate and your policy's actual performance. This will show if your policy is on track or if you need to increase premium payments to keep it from lapsing. Failure to conduct these reviews is one of the primary reasons UL policies fail, leaving individuals in their later years without the coverage they counted on.

Conclusion: Is Universal Life Right for You?

Universal Life insurance can be a powerful tool for individuals with fluctuating incomes, complex estate planning needs, or those seeking permanent coverage with some upside potential. However, it is best suited for sophisticated buyers who are financially disciplined, understand the risks, and are committed to actively managing the policy for decades.

Before signing, work with a fee-only financial advisor (not just the selling agent) to analyze the illustration. Ensure you fully comprehend the guarantees versus the projections, all associated costs, and your responsibility in maintaining the policy. For many, the simplicity and guarantees of term life or whole life insurance may be a more appropriate and secure choice. Your life insurance should provide certainty; make sure your UL policy doesn't introduce more risk than you're willing to bear.