What drives the guaranteed minimum death benefit under a variable life policy?

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If you’re in the market for a life insurance policy with lifelong coverage, universal life insurance might be the right choice for you. Universal life insurance can offer a guaranteed death benefit, allows you to tap into the policy’s cash value, and may give you the flexibility to adjust your premium payments and death benefits.

We’ll walk through what you need to know about universal life insurance and break down the different types of universal life policies. Make sure you’re working with a trusted financial advisor or experienced life insurance agent when considering these policies. They can be complex.

How Does Universal Life Insurance Work?

Universal life insurance is a type of permanent life insurance. Unlike term life insurance, which is meant for a specific period, such as 20 years, universal life insurance is in effect for the rest of your life (unless you stop making premium payments).

Some forms of universal life insurance also offer a cash value component. You can take money out of cash value via a withdrawal or loan. When you die, the insurance company will reduce the death benefit payout to your beneficiaries by the amount of any withdrawals or outstanding loans. But for some buyers, accessing cash value is more important than a full payout to beneficiaries later on.

Related: Best Life Insurance Companies

There are a few types of universal life insurance policies and it’s crucial to understand what you’re buying. Their costs and features are quite different.

Typically, guaranteed universal life has the lowest risk, while variable universal life has the most risk because the cash value is tied to stocks and bonds. On the flip side, you can potentially build more cash value with indexed universal life and variable universal life than guaranteed universal life.

If you’re considering a universal life insurance policy, think about how much risk you’re willing to take on. Don’t be sold on promises of big investment gains that might not come true. Be sure to examine the guaranteed portions on the policy illustration and not just the rosy projections.

Comparison: Types of Universal Life Insurance

Overall, universal life insurance policies have the largest market share based on premium, according to third quarter 2021 figures from LIMRA, an industry-funded financial services research company. Indexed universal life and fixed universal life make up 34% of life insurance premiums. Variable universal life makes up another 13%.

Guaranteed Universal Life Insurance

A guaranteed universal life (GUL) insurance policy offers a death benefit and premium payments that will not change over time.

You select an age at which the policy ends (such as age 90, 95, 100, 105, 110, or 121). Choosing a higher age will increase the premium.

Guaranteed universal life insurance generally has little or no cash value and is typically the cheapest kind of universal life insurance you can buy. You’re paying for the lifelong coverage, similar to a whole life policy.

GUL is sometimes called “no lapse guarantee universal life insurance.” This is to address recent problems in which traditional, non-guaranteed universal life insurance policies lapsed because the cash value couldn’t cover the policy’s expenses and the cost of insurance. Some policyholders who wanted to keep their insurance in force had to suddenly pay much larger premiums that they never expected.

These newer no-lapse policies promise to stay in force. But there’s a catch: If you make a late payment or miss one, the policy will likely terminate. Since there’s usually no cash value, there won’t be any money to take away. The insurance company will keep the premiums you paid.

Who may benefit from a guaranteed universal life insurance policy?

Guaranteed universal insurance insurance can be a good choice for someone looking primarily for lifelong coverage and who cares less about the “investment” component of cash value. Unlike other types of universal life insurance, a GUL policy doesn’t offer flexibility with the premium payments or death benefit amount.

What if I no longer want my guaranteed universal life insurance policy?

Financial situations can change over the years and you may find that you no longer want the GUL policy. There may be little cash value in a GUL policy, so there could be little money to take if you surrender the policy.

But some companies offer another way out: In some cases a return of premium rider can be added when you buy the policy. These riders give you the option to take a partial or full refund on the premiums you’ve paid, but only at certain points after you buy the policy.

Within a time window such as 60 days of specific years after the policy purchase, such as 15, 20 or 25 years, you can give up the policy and get some or all of your premiums back. The percentage returned to you can be based on the policy year, the policy face amount, and/or the age at which you bought the policy, depending on the company.

Here, too, if you’re interested in this option make sure it’s built into the GUL policy before you buy it.

Average cost of guaranteed universal life insurance

Averages below are examples of annual rates for a $1 million GUL policy for healthy non-smokers, guaranteed to age 100 or older.

Indexed Universal Life Insurance

Indexed universal life insurance (IUL) offers lifelong coverage and may have some flexibility with the death benefit and premiums. You may be able to adjust your death benefit and payments within certain limits if your needs or budget change.

There’s a cash value component in IUL that’s often tied to a stock market index, such as the Nasdaq-100, S&P 500 or a combination of indexes. You might also have the option of a fixed-interest investment.

When you pay premiums, part of the money goes to (potentially high) policy fees and charges, and the remaining goes into cash value.

It’s important to understand the boundaries of your potential investment gains. Indexed universal life insurance policies have participation rates and caps. The participation rate is a portion of the index gains that your cash value will actually receive. For instance, if your index went up 10%, and you have a participation rate of 50%, you’ll gain 5% upside. Additionally, there’s usually a cap, which is the maximum percentage you can gain no matter how well the index performs.

If your index plummets, you’ll still have a “floor” that guarantees a minimum return rate, which can be 0%. Still, it’s possible to lose all your cash value if policy charges and expenses eat through your money.

Owning an IUL policy doesn’t mean that your money is actually invested in the index. In reality, insurers still mainly invest in bonds. So the index is just a barometer to calculate cash value gains and losses. And the calculation of your gains won’t include any dividends that you might otherwise pocket if you invested directly.

Despite its complexity, indexed universal life insurance is a popular product. That may be largely due to advisors steering clients toward these policies.

If you’re considering buying indexed universal life, make sure you understand what you’re buying. The Center for Economic Justice issued a warning in July 2020 that consumers should not buy indexed universal life insurance. The consumer advocacy group cites misleading and deceptive sales practices involving IUL.

“Consumers should avoid IUL because the insurers and agents who sell the product have no obligation to work in the consumer’s best interest. Mix in massively complex products designed to juice illustrations with opaque and unaccountable features and you have the recipe for future financial disaster,” said Birny Birnbaum, director of the Center for Economic Justice, in a statement.

Advisors selling IUL may tout policies based on the rosy pictures painted in policy illustrations. Illustrations often focus on non-guaranteed elements of the policy, such as cash value gains and loans against cash value that look like they won’t cost anything.

But non-guaranteed parts of the policy are just that—projections that might never happen. Policyholders could potentially shell out far more in premiums than they expected to keep a policy in force.

Make sure to examine the guaranteed parts of a policy illustration and ask yourself if you’re OK if that is the reality.

One way to get a better perspective on a policy is to ask your advisor or agent to order a report from Veralytic on the suitability of the product for you. Veralytic is a life insurance analytics firm that measures the qualities of cash value life insurance products and the companies offering them.

Who may benefit from an indexed universal life insurance policy

Someone who wants flexibility to make changes to a death benefit and premiums and who is OK taking on more investment risks may find an IUL policy appealing.

Variable Universal Life Insurance

Variable universal life (VUL) insurance also allows you to vary premium payments and the death benefit amount, within limits. You’ll generally need to actively manage this kind of policy because you’ll select sub-accounts for your cash value investments. You may also be able to choose a fixed interest rate option for cash value.

With variable universal life insurance, you have a potential for good returns on your cash value (if you’ve invested wisely) and you have a certain level of control over your investments.

But your cash value could also tank if the investment choices bottom out. Also, these policies tend to have higher fees than other universal life policies and are often a lot more complex.

Who may benefit from a variable universal life insurance policy

A person who wants to take an active role in choosing the sub-accounts for the policy’s cash value may be attracted to VUL policies. A variable universal life insurance policy would likely not be good for a person who wants a passive investment or who is risk averse.

Other Types of Universal Life Insurance

• Cash accumulation UL: A universal life insurance policy that’s specifically designed to build up cash value quickly early on.
• Current assumption UL: A traditional UL policy designed to offer coverage at a low cost because the death benefit is not guaranteed. Your cash value grows based on the “crediting rate” offered by the insurer, which can change the rate. You may be able to change the timing or amounts of your payments, or modify the death benefit, but you need to make sure that your policy account contains enough money to cover the policy’s fees, the cost of insurance, and any loans or withdrawals you’ve taken. If it doesn’t, the policy could lapse. These policies have been under scrutiny recently, after some policyholders got hit with large, unexpected premium increases when their cash value fell below the minimum requirements.

How to Take Money from Cash Value

You generally have a few options when it comes to taking the cash value from a policy. Make sure you understand the policy’s rules for taking out cash value and all of the financial implications that come with that decision.

• Withdraw funds from your cash value: You could make a tax-free withdrawal from your policy. However, if you withdraw more cash value than the portion funded by your premium payments, the investment gains you take are taxed as income. Also, taking out cash value will reduce your death benefit and your beneficiaries will receive less.
• Borrow against your policy: Typically, you can borrow tax-free from the cash value of your policy. If you die before the loan and interest are repaid, the outstanding balance will be subtracted from your death benefit.
• Surrender the policy: If you decide you no longer want or need life insurance, you can contact the insurer to surrender the policy. You’ll receive the cash value minus any surrender charge.

Adding Riders to Universal Life Insurance Policies

Like other life insurance policies, you can add riders to universal life policies. Life insurance riders are a way of adding extra coverage or features, usually at extra cost.

For example, one comom rider is a “waiver of premium” rider. If you become fully disabled and have this rider, the insurance company will waive further premium payments.

An accelerated death benefit rider is often automatically included with policies at no additional cost. It lets you take money from your own death benefit if you are diagnosed with a terminal illness. (Rules for when you can tap into the money vary by company.) Other common options are chronic illness riders and long-term care riders, which both let you take money from the death benefit when you have certain health conditions.

Medical Exams for Universal Life Insurance

Many sellers of universal life insurance use “full underwriting,” meaning they take time to examine your application, verify information and require that you do a life insurance medical exam.

The medical exam usually includes height, weight, blood pressure, and blood and urine samples. It’s generally done by a paramedical professional hired by the insurance company and can be done at home.

There’s a wide variety of data about you available to insurers, who can use it in pricing policies. This includes data on consumer credit, your prescription drug history, your answers on past individual health and life applications, and your motor vehicle record. It’s also common for insurers to request your medical records.

Who Should Consider Universal Life Insurance?

If you want life insurance coverage that lasts the duration of your life, you might consider a universal life insurance policy. For example, universal life insurance can fund a trust to take care of a special needs child or other dependents after you’re gone.

You might also consider a universal life insurance policy if you have big long-term savings goals and need both an investment vehicle and life insurance, but only after you’ve maximized other savings options such as retirement plans.

Alternatives to Universal Life Insurance

Universal life isn’t the right choice for everyone’s situation. Other types of life insurance might be better, depending on the policy length and guarantees you want.

Whole life insurance: Lots of guarantees at a high cost

Like universal life insurance, whole life insurance gives you coverage for the duration of your life. It also includes a cash value component.

The biggest difference between whole life insurance and universal life insurance is the cost: Whole life insurance is generally the most expensive way to buy permanent life insurance because of the guarantees within the policy: Premiums are guaranteed not to change, the death benefit is guaranteed and cash value has a minimum guaranteed rate of return.

Also, indexed and variable universal life can give you flexibility with payments and the death benefit amount after you buy the policy.

Whole life insurance, on the other hand, guarantees that your premiums, the cash value guaranteed rate of return and the death benefit won’t change. Whole life insurance is suitable for someone who likes predictability and is willing to pay for it.

In addition, many whole life insurance policies pay dividends. These are like annual bonuses paid by mutual insurance companies to customers, although not guaranteed. You can use dividends to pay premiums, add it to your cash value or simply take the money.

Term life: Cheapest life insurance option

Term life insurance offers level premium for a set time period, such as for 5, 10, 15, 20, 25 or 30 years. It doesn’t have a cash value component. But it’s the cheapest way to buy life insurance. For example, you could buy a 20-year policy to cover young children’s growing years and college time. Or a 30-year policy when you buy a house and take out a mortgage.

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Frequently Asked Questions (FAQs)

Should I cash out my universal life insurance policy?

A main reason to cash out a universal life insurance is that you no longer need life insurance. But before you take the cash and run, make sure you won’t need life insurance in the future. Life’s circumstances can change, and you don’t want to regret cashing out a policy.

If you need cash now, consider taking a loan against the policy rather than cashing it out. That gives you options in the future, including keeping the life insurance in force.

What happens to cash value in a universal life policy at death?

Cash value in life insurance is really meant to be used during your life. Once you pass away, any cash value generally reverts back to the life insurance company. Your beneficiaries get the death benefit, not the death benefit plus cash value. That said, some policies will include cash value in the payout, but are more expensive.

What is guaranteed in a variable life policy?

What is the death benefit in a variable life policy?

Which life insurance policy guarantees a minimum death benefit?

Is a minimum guaranteed death benefit provided in a variable whole life policy?