Universal Life Insurance (UL)

1. 1

   The premium is received

   Any premium expense charge or percent-of-premium load the contract applies is taken first. What remains is added to the policy value.

2. 2

   Charges are deducted from the policy value

   On the contract's schedule, usually monthly. New York's DFS describes the two components: the company's expenses, and the cost of insurance protection, usually described as the mortality deduction charge.

3. 3

   Interest is credited to what remains

   At the rate the insurer has declared, and never below the contract's guaranteed minimum.

4. 4

   The cycle repeats, every month, for as long as the policy is in force

   Charges continue whether or not a premium was paid that month, and whether the declared rate went up, down or nowhere.

This is the feature universal life is known for, and the one most often misunderstood. New York's DFS describes the appeal accurately: universal life allows you to change or skip premium payments, or change the death benefit, more easily than with any other policy. What follows from that is less often described, and it is the part that decides whether the policy is still there in thirty years.

• Flexible means within the contract's limitsMinimums, maximums and timing are all defined by the policy, and federal tax law separately caps how quickly a life insurance contract may be funded.
• The charges do not flexCost of insurance and the policy's other charges are deducted on schedule regardless of what you paid. Paying less simply means more of the charge comes out of existing value.
• Skipping is not pausingThe policy keeps running and keeps charging. Maryland's insurance administration puts it plainly: if your planned premium is not enough to cover the cost of insurance and other charges, the additional money is deducted from the policy's cash value.
• The planned premium is a plan, not a guaranteeUnless the contract contains a guarantee that says otherwise, no premium figure on an illustration promises the policy will stay in force. It shows what happens if a set of assumptions holds.
• The insurer has to warn youThe model regulation requires the annual report on a flexible premium policy to include a notice if the net cash surrender value will not maintain the insurance in force until the end of the next reporting period unless further premiums are paid.

Universal life contracts commonly offer more than one death benefit structure, and many also allow the amount to be changed later. New York's DFS describes the usual choice: under one option beneficiaries receive only the face amount of the policy, and under the other they receive both the face amount and the cash value account. Labels differ between insurers — Option A and Option B, or Option 1 and Option 2 — and the contract governs.

• A level death benefitBeneficiaries generally receive the face amount. As policy value builds, the amount of pure insurance the insurer carries shrinks, which can hold down the cost-of-insurance charge.
• An increasing death benefitBeneficiaries generally receive the face amount plus the policy value. More insurance stays in force and the cost-of-insurance charge is correspondingly higher, which means the policy needs more funding to do the same work.
• The choice changes the funding requirementBecause the option determines how much risk the insurer carries each month, it moves the charge deducted from your value — and therefore how much premium the policy needs. It is not a presentational preference.
• Adjusting the amount laterMany contracts permit an increase or decrease, and the flexibility is part of how the NAIC defines the product. An increase generally requires new evidence of insurability, and a decrease may be limited by minimum face amounts, by surrender charges, or by federal tax-law requirements. Not every contract allows every change.

Most universal life contracts allow the owner to take value out during their lifetime, by loan or by withdrawal. Both reduce what is available to support the policy, and on a flexible-premium contract that is not a neutral act.

• A loan is secured by the policyThe insurer lends against the contract and holds it as security. Interest applies, at a rate the contract specifies or determines.
• Unpaid interest is generally added to the balanceSo the balance grows, and grows faster the longer it is left. Over decades a loan can reach a size the policy value cannot support.
• An outstanding loan reduces what is paidBoth the death benefit payable to beneficiaries and the amount available on surrender are generally reduced by the amount owed.
• A withdrawal is different, and permanentMoney withdrawn leaves the policy and does not return. It generally reduces the policy value, may reduce the death benefit, may carry a charge, and may be limited by the contract.
• Either can affect a guaranteeWhere the contract includes a secondary guarantee, loans and withdrawals commonly count against it. Depending on the contract, taking one may reduce or end the guarantee entirely.
• Both raise lapse riskLess value in the policy means less to absorb the charges — and on a policy already relying on its value to cover a shortfall, that is the sequence that ends coverage.

Universal life is subject to the same federal funding limits as any other life insurance contract. A modified endowment contract, or MEC, is one funded faster than those rules allow for the usual treatment. The IRS states the test: a contract fails the seven-pay test if the accumulated premiums paid at any time during the first seven years exceed what would have been paid if the contract provided for seven equal annual premiums. A contract that fails is still life insurance. What changes is how money taken out during the insured's lifetime is treated.

• Because premiums are flexible, it is possible to pay in enough to cross the line
• This is most likely where a policy is being funded heavily for its value rather than for its death benefit
• Certain changes to an existing contract can trigger a fresh test
• Where a contract becomes a MEC, that status generally stays with it
• Insurers monitor this and will normally tell you before a payment would cross the line

Life insurance receives particular treatment under federal tax law. The accurate version is narrower than the language usually built around it, and the situations are worth keeping separate. On death proceeds, the IRS states that life insurance proceeds received as a beneficiary due to the death of the insured generally are not includable in gross income and do not have to be reported — with exceptions, including where proceeds are paid in instalments and interest is involved, and where the policy was transferred for valuable consideration. On surrender, the IRS is equally direct: if you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the policy. It defines that cost as the total premiums paid less any refunded premiums, rebates, dividends, or loans that you neither repaid nor previously included in income. And for the contract to be treated as life insurance for federal tax purposes at all, it has to satisfy tests set out in the Internal Revenue Code.

• Growth retained inside a qualifying contract is generally not taxed while it stays there
• How lifetime distributions are treated depends on the contract, the amounts, the policy's basis and MEC status
• A lapse or surrender with a loan outstanding is not treated like a policy that simply ends
• State tax treatment and estate tax are separate questions from federal income tax
• Tax law changes, and a universal life policy is likely to be held for decades

Guaranteed universal life is a universal life policy designed around a long-term death benefit guarantee rather than around cash-value growth. It uses the same architecture as everything else on this page — flexible premium, policy value, charges deducted — but it is aiming at something different, and it is usually priced and funded accordingly. People sometimes describe it as "term to 100" or as a cheaper alternative to whole life. Both descriptions are rough, and the second one in particular is misleading.

• The guarantee is the productWhat is being bought is coverage that stays in force to a stated age or for life, provided the contract's funding requirements are met. Cash value is largely incidental to that objective.
• There may be very little cash valueMany GUL designs build modest value, and some build almost none. Surrender value can be small or nil, which makes this a poor choice for anyone who might want the money back.
• The premium is not flexible in practiceThe contract may permit variation, but the guarantee generally will not. Meeting its conditions usually means paying a specified amount on a specified schedule — which is the opposite of how universal life is usually described.
• It is not whole lifeWhole life carries a guaranteed schedule of cash values written into the policy, and its guarantees rest on that structure. A GUL policy's guarantee rests on a contractual secondary guarantee instead. Both can produce lifetime coverage; the mechanics, the values behind them and what happens if you deviate are different.
• Designs vary substantiallyGUL is a description of intent rather than a standardised product. Two policies both sold as guaranteed UL can differ in the length of the guarantee, in what maintains it, and in how much a missed or late payment costs.

A secondary guarantee is a contractual provision that can keep coverage in force even when the policy's account value would not otherwise support it. The NAIC's actuarial guidance on these products describes the mechanism directly: a universal life policy guarantees the coverage to remain in force as long as the accumulation of premiums paid satisfies the secondary guarantee requirement. That sentence is worth reading twice, because the condition sits inside it. The guarantee does not track your account value. It tracks whether you have met a separate requirement — and that requirement is defined by the contract.

• It runs on its own testSome designs use a specified premium requirement: pay at least a stated amount on a stated schedule and the guarantee holds. Others run a separate internal calculation — often called a shadow account — that exists only to determine whether the guarantee is intact. It is not your cash value, and you cannot spend it.
• Not every universal life policy has oneThis is a feature, not a characteristic of the category. Assume nothing; ask whether the specific contract includes one.
• The conditions are exactWhere a guarantee depends on premium amount and timing, it generally means that amount and that timing. Paying late can matter as much as paying less, depending on the contract.
• Some run to an age rather than for lifeA guarantee to 90 and a guarantee to 121 are different products at different prices. Which one is being proposed is a question worth asking explicitly.
• Losing one is often permanentDepending on the contract, a broken guarantee may be restorable by a catch-up payment, or may not be restorable at all. This is the single most important thing to establish before relying on one.

• Depending on the contract, a guarantee can be reduced or ended by: paying less than the required amount
• Paying the right amount late, even by a short period
• Taking a policy loan, or leaving loan interest to accumulate
• Taking a withdrawal or partial surrender
• Increasing or decreasing the death benefit, or changing the death benefit option
• Adding, removing or changing a rider
• Other changes the specific contract identifies

This is the risk that defines universal life, and it is worth stating without softening. A UL policy stays in force while the policy value can cover the charges due, unless a contractual guarantee provides otherwise. The NAIC's model regulation defines lapse for a flexible premium policy as the date on which the net cash surrender value first equals zero, and requires a grace period of at least thirty days after that point.

• Insufficient premiumThe most common cause, and the most preventable. Paying the minimum, or paying less than the illustration assumed, leaves the least margin.
• Credited interest below what was assumedThe mechanism behind a great many older policies. A rate lower than the one illustrated means less growth against unchanged charges, year after year.
• Cost of insurance rising with ageThe deduction is not level across the life of the policy, and insurers may adjust current rates within the contract's maximums.
• Loans and accumulated loan interestA growing balance reduces what is available to support the policy — and a lapse with a loan outstanding carries tax consequences a simple lapse does not.
• WithdrawalsValue taken out is value that is no longer there to pay charges or to recover when conditions improve.
• Guarantee conditions not metWhere the coverage was relying on a secondary guarantee, failing its conditions removes the thing that was holding the policy up.
• Nobody lookingThe one that turns all of the above from a problem into a loss. Policies bought decades ago have lapsed in old age, when replacing the coverage was expensive or impossible.

Universal life is the permanent product least suited to being bought and forgotten, and New York's DFS says so plainly: you will need to actively manage the policy to maintain sufficient funding, especially because the insurance company can increase mortality and expense charges. The good news is that most of what you need arrives in the post. The NAIC's model regulation requires the insurer to send an annual report showing the policy value at the start and end of the period, everything credited or debited during it identified by type, the current death benefit, the net cash surrender value, and any outstanding loan.

• The policy value at the end of the period against the previous one — is it going up or down?
• The current declared rate, and how it compares with the rate the policy was illustrated on
• Whether the premium being paid is still enough, especially after a change in rates or charges
• Any outstanding loan balance, and how fast it is growing
• Where the policy has a secondary guarantee, whether it is still intact
• Any lapse notice the report contains — the model regulation requires one where the value will not carry the policy to the next report