How Do Universal Life Insurance Policies Work?

Universal life insurance offers flexibility, guaranteed coverage and interest earnings.

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Universal life insurance offers more flexibility than term or whole life insurance, along with a tax-deferred method of investing. You may pay a higher premium when you can afford it, and sometimes you can skip the payments when you can't. This type of insurance works well for seasonal workers or those on commission. You are guaranteed coverage for as long as you maintain the minimum cash value. You can change the death benefit on your policy at any time. If you modify your death benefit, you must adjust the premium to account for the change in the cost of insurance.


Premiums for universal life insurance are flexible and can vary over the term of the policy. You must pay a minimum premium in the first few years or your policy will be canceled. After your policy reaches a certain level of cash value, you might be able to reduce or discontinue your payment. You must maintain enough cash value to pay the cost of the insurance policy. Premiums and interest increase the cash value. There could be limits on how far in advance you pay your premiums.


A fixed universal life policy pays a set interest rate on the cash value of the policy. Indexed universal life insurance offers a rate based on increases in a specific stock index, and drops in the index don't affect the value of this type of policy. A variable policy invests the cash value in stocks, bonds and mutual funds. With this type of policy you bear the risk of loss if the underlying investments drop in value.


Cash value and insurance cost are not related in a universal life insurance policy, so you run the risk of having your policy canceled if conditions change rapidly. You might be forced to pay a large premium to cover the increased insurance costs. The insurance company takes its fees out of your policy's cash value. Keep track of the market rate that's tied to your policy. When it drops, your cash value might not be enough to cover the insurance costs and fees unless a supplemental premium is paid.

Withdrawal and Surrender

You can withdraw part of the policy's cash value at any time without penalty. Make sure the value does not drop so low that your policy is canceled. After 10 to 15 years, you may surrender the entire policy and withdraw your cash value without any surrender charges.