Universal life insurance works like whole life and is a type of permanent coverage. Similar to whole life insurance, universal life has both a death benefit and a cash value component. These policies are considered to be more flexible than whole life, though.
Based on the terms of a universal life insurance policy, the “excess” premiums (i.e., those that are not used for funding the policy’s death benefit) are credited to the policy’s cash value, which is then credited with interest each month. The funds in the cash value are allowed to grow tax-deferred.
The owner of a universal life insurance policy may be able to skip premium payments if there is a sufficient amount of cash to fund the insurance component. Universal life may be used as a funding tool for paying the insured’s final expenses, as well as for:
- Payoff of debts
- Estate tax payment
- Business succession
- Income replacement
- Deferred compensation and / or executive bonus plans
<p”>Many universal life plans will also offer “living benefits,” where a portion of the death benefit may be accessed by the insured if he or she has a terminal illness and / or they need to reside in nursing home for a certain amount of time
An indexed universal life (IUL) policy has its cash value return based on the performance of an underlying market index, such as the S&P 500. With these policies, the cash value has the opportunity to obtain market-linked returns – usually up to a certain maximum, or “cap.”
However, if the underlying index performs poorly during a given period of time, the cash value will not be credited with a loss. Rather, it will be credited with a 0% for that period. So, while there is no gain for that time period, there will also be no loss to the policy’s cash component.
Indexed universal life insurance policies can provide a way to take advantage of upward moving markets without having to put principal at risk. In addition, similar to with other types of permanent life insurance policies, the cash inside of an indexed universal life plan is allowed to grow tax-deferred.