Universal life insurance explained

A term life insurance policy is sold with up to a thirty year period. You can buy longer terms but the rates are higher, reflecting the higher risk of death during the longer period. So if you're currently forty and buy a twenty-five year term, you get the benefit of knowing your family is protected up to the age of sixty-five but, when you reach that age, the policy just goes away. With a universal policy, you decide the minimum benefit, get life insurance quotes and pay the monthly installments. All the money above a defined percentage of your premium payments goes into a cash value which attracts interest in a specified range or the investment can be linked to an index, e.g. a stock exchange. Although it may be controversial to link to the stock exchange, historically, shares have outperformed the returns from bonds. It's true the stock values crashed in 2008, but the Dow has recently recovered to 2008 levels and is pushing on to previous highs.

Universal life insurance protect your benefits until you die although there's a new trend reflecting the increase in life expectancy. A small number of policies now write in a cut-off age, i.e. even though you may still be making your installment payments, the insurer's liability to pay ends at one-hundred-twenty years. This is effectively creating a penalty for living longer than expected by switching the policy to term life.

Alternatively, some policies are allowing overfunding. Let's say you have reached a point in your life when most of the debts are under control and your earnings are high. If you pay more than you're contracted to pay each month, this can trigger higher rates of interest on the surplus. You can also reach a point when the insurer can deem the policy fully paid-up. This means you would be covered for the rest of your life without having to pay a cent more. This is particularly important if you started the policy early in your life. The initial annual premium is based on your life expectancy at the time you buy the policy. So if you buy at the age of twenty, you may be expected to live another sixty years before a claim is made. The rate set will be low. As your earnings grow, the life insurance payments become a small percentage of your paycheck. Paying more becomes affordable. Why should you want to pay more? Because the investment is paid tax free on death or is sheltered from tax until withdrawn.

This means we must distinguish Level Cost Premiums where the premium rate is fixed during your life, and policies which have a Yearly Renewable Term. YRT policies shift the balance in the premium payments as you get older with an increasing percentage going into life insurance and the decreasing percentage going into the investment option. If your investment choices are poor, you can be asked to top up your premium payments.