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 Universal Life Insurance

Universal life insurance policies are designed to offer coverage for a lifetime. Unlike whole life insurance, which is typically intended as an investment vehicle rather than a pure insurance product, universal life policies are marketed as a combination of the investment and personal risk management aspects of whole life.

The key features of universal life policies are paid premiums (which may be adjusted higher than those on other types of policy) and tax-deferred accumulation that leads to cash value accumulation and investment in the policy's own equity. These features allow for interest credits on premiums above those required to pay current policy liabilities, whether at death or during subsequent loan withdrawals, thus producing built-in savings over time that can enhance retirement income sources.

Universal life insurance is an individual life insurance policy in which the death benefit and premiums can vary. The death benefit is based on the policy's current cash value rather than on a fixed face amount. Universal life policies are issued as either participating or non-participating. Non-participating universal life policies do not participate in gains made by the underlying assets held in the policy's cash value account and therefore are more likely to be purchased by investors who are comfortable with greater risk. Participating universal life policies participate in investment gains made by the underlying assets held in the policy's cash accumulation account and therefore may be appropriate for higher-income earners who desire additional protection against risk of investment loss over time.

Unearned premiums are not limited to 5% of the insured amount. As long as there is no lapse in coverage, unearned premiums are included in the cash value accumulation balance and interest is earned on the accumulated cash value at a nominal rate. The policy may have a maturity of up to 100 years.

The insured may elect to convert their universal life insurance policy into a permanent life insurance policy upon retirement, disability, or other age-based event by following simple application of federal income tax laws through the surrender of the policy and receipt of an appropriate federal income tax benefit.

The current cash value (death benefit) of a universal life policy accumulates for the insured's lifetime. The cash value inherited from the policy at death is subject to federal income tax upon withdrawal and must be repaid the estate. Payments from the cash value may be made by any method allowed by law, including regular or accelerated payments, in lump sum or in installments.

Conversion of a universal life policy into a permanent life insurance policy has no impact on the policy's tax treatment or ongoing premium payments for future coverage.

On death, all of an insured person's universal life insurance policies owned within a company are paid to their beneficiary according to specified payment schedules. Any cash values that remain after death will be payable based on criteria that may dictate when payments are made. These criteria may include whether the insured's spouse is younger or older than the insured, whether there are children, and when the insured dies.

The death benefit of a universal life policy is based on the current cash value rather than on a fixed face amount. The cash value may be used to pay premiums but cannot be withdrawn by other means until policy maturity. It may also earn dividends, which may increase its value. Most companies will allow policy owners to access their cash value through flexible payment options such as accelerated payment, level payment or partial withdrawal. These options can vary from company to company.

Beginning in 2015, the U.S. Department of Labor (DOL) has redefined how universal life insurance will be treated for insurance policy surrender purposes. Policies issued or reissued after December 31, 2014, will be treated as variable universal life insurance policies under this new DOL ruling. Despite the regulatory changes, investors still are able to surrender their policy for its cash value at any time and without penalty. As long as the withdrawal is not over-funded and no one is misled about the meaning of surrender value on a policy's sticker, policies issued before 2015 can still be surrendered without any penalties or tax implications.

In most cases, surrender value is determined by a company's cash surrender value and is calculated by taking the sum of all remaining policy premiums and policy loans in the policy's life expectancy value pool, plus the cash value of any benefits received from policies or policies taken out as loans.

Investors can purchase non-participating universal life insurance policies for amounts well above $100,000 ($250,000 for some Delaware life insurance companies). To limit investment risk, it is common to purchase certain limits on the death benefit. For example, an 80-year-old may purchase a 20-year non-participating universal life insurance policy that offers an initial death benefit of $500,000. His initial premium would be $50,000 a year. The policy could provide the death benefit of:

$500,000 × (0.8 percent) × 20 years = approximately $323,000 from time of policy issue

After approximately 18 years of what the insured believes to be continuous coverage (the company has not refused a claim), the insured may opt to surrender the policy and receive its cash value in a lump sum payment at age 70 rather than continue to pay premiums into the policy.

A non-participating universal life policy may be appropriate, for example, for an investor who has accumulated a substantial retirement nest egg and wishes to transfer some or all of that investment capital to a tax-advantaged life insurance policy with the intent of enjoying current income without taking taxable distributions from his or her retirement account. The death benefit of the universal life policy may provide tax-free dollars when received by the surviving beneficiaries.

Participating policies are sold in varying increments, with the ability to participate or not participate at each level. The insurance company agrees to pay a portion of the cash value. Depending on the policy, payments can range from 40 to 100 percent of the cash value. The participating policyholder receives tax-free income in exchange for a lower death benefit than non-participating policies. In most cases, participating policies will have premiums that are calculated on the "level" method, meaning that they stay constant for up to 10 years (see below).

Participating life insurance policies are also called "living benefits policies," because they provide an immediate income stream during the insured's lifetime as opposed to non-participating life insurance which provides a one-time payment at death.

Conclusion

Participating universal life insurance provides the cash value buildup and death benefit flexibility of universal life coverage, with the added benefit of income from participating premiums. The decision to participate is made through a set-percentage amount declared at outset of the policy. Policyholders can choose to participate in varying levels, which determines their monthly payments and monthly benefits.

Proceeds from a participating policy never have income tax liability associated with them because they are not considered taxable distributions when received by beneficiaries. A participating life insurance policy offers flexible how and when you want your money options as well as tax benefits.