Universal Life Insurance

Universal Life Insurance is a type of permanent life insurance based on a cash value. That is, the policy is established with the insurer where premium payments above the cost of insurance are credited to the cash value. The cash value is credited each month with interest, and the policy is debited each month by a cost of insurance (COI) charge, and any other policy charges and fees which are drawn from the cash value if no premium payment is made that month. The interest credited to the account is determined by the insurer; sometimes it is pegged to a financial index such as a bond or other interest rate index.

Universal Life Insurance is used as a tax-advantaged way to purchase life insurance. In the early years of the contract, the premium far exceeds the cost of insurance (COI) charges. The difference between the two (the "cash value") will grow tax-deferred so long as the policy remains in force. If the policy is held until death, the cash value will escape taxation entirely. This is because the premiums are paid with after-tax money, so the money going in has already been taxed, and only growth would be taxed. As long as the policy has not become a MEC (Modified Endowment Contract) it will not have a tax deferred status. Any gain in the policy will remain non-taxable unless withdrawn. Also the death benefit of life insurance policies generally does not face income tax as long as the policy was not received as a result of payment by you to the previous owner of the policy

Types of Universal Life Insurance

Single Premium :
A Single Premium UL is paid for by a single, substantial, initial payment. Some policies do not allow anymore than the one premium contractually, and some policies are casually defined as single premium because only one premium was intended to be paid. [6] The policy remains in force so long as the COI charges have not depleted the account. These policies were very popular prior to 1988, as life insurance is generally a tax deferred plan, and so interest earned in the policy was not taxable as long as it remained in the policy. Further withdrawals from the policy were taken out principle first, rather than gain first and so tax free withdrawals of at least some portion of the value were an option. In 1988 changes were made in the tax code, and single premium policies purchased after were "Modified Endowment Contract (MEC)" and subject to less advantageous tax treatment. Policies purchased previous to the change in code are not subject to the new tax law unless they have a "material change" in the policy. (usually this is a change in death benefit or risk) It is important to note that a MEC is determined by total premiums paid in a 7 year period, and not by single payment. The IRS defines the method of testing whether a life insurance policy is a MEC. At any point in the life of a policy, a premium or a material change to the policy could cause it to lose its tax advantage and become a MEC.

Fixed Premium :
Fixed Premium UL is paid for by periodic premium payments associated with a no lapse guarantee in the Universal Life Insurance policy. Sometimes the guarantees are part of the base Universal Life Insurance policy and sometimes the guarantee is an additional rider to the policy. Generally these payments will be for a shorter period of time than the policy is in force; for example payments may be made for 10 years, with the intention that thereafter the policy is paid-up. But it can also be permanent fixed payment for the life of Universal Life Insurance policy.
Since the base policy is inherently based on cash value, the fixed premium policy only works if it is tied to a guarantee. If the guarantee is lost, the policy reverts to it flexible premium status. And if the guarantee is lost, the planned premium may no longer be sufficient to keep the coverage active. If the experience of the plan is not as good as predicted, the account value at the end of the premium period may not be adequate to continue the policy as originally written

Flexible Premium :
Flexible Premium UL allows the policyholder to vary their premiums within certain limits. Inherently Universal Life Insurance policies are flexible premium, but each variation in payment has a long term effect that must to considered. In order to remain active, the policy must have sufficient available cash value to pay for the cost of insurance. Higher than expected payments could be required if the policyholder has skipped payments or has been paying less than originally planned. It is recommended that yearly illustrative projections be requested from insurer so that future payments and outcomes can be planned.

Universal Life Insurance - Withdrawals

Most Universal Life Insurance Policies come with an option to withdrawal cash values rather than take a loan. The withdrawals are subject to contingent deferred sales charges and may also have additional fees defined by the contract.Universal Life Insurance Withdrawals will permanently lower the death benefit of the contract at the time of the withdrawal.

Withdrawals are taken out premiums first and then gains, so it is possible to take a tax free withdrawal from the values of the policy. (this assumes the policy is not a MEC) Withdrawals are considered a material change and cause the policy to be tested for MEC. As a result of a Universal Life Insurance withdrawal, the policy may become a MEC and cause lose its tax advantages

Withdrawing values will effect the long term viability of the Universal Life Insurance. The cash values removed by loan are no longer earning the interest expected, so the cash values will not grow as expected. To some extent this issue is mitigated by the corresponding lower death benefit. An illustration showing the effect of a withdrawal is recommended in order to assess the outcome of this change.