Universal life insurance is a permanent policy that doubles as an investment product. It works in a similar way to other permanent policies — but it’s unique in terms of its flexibility and the way the cash value grows.
What is universal life insurance?
Universal life insurance is a permanent policy with a savings component. Along with offering lifelong coverage, it builds cash value (also called the cash surrender value, or CSV) over time and often gives you the freedom to adjust your premium and death benefit.
How does universal life insurance work?
While each universal life insurance policy will vary in its features, generally you can expect that a portion of your premiums will go towards the death benefit, while another portion is invested to build up the cash value. The cash value grows through accounts that offer a fixed interest rate set by the insurer, interest earned from a chosen investment portfolio, or returns tied to the performance of a stock index.
Once you’ve accumulated enough cash value, you’ll be able to take out loans against your policy. Eventually, you may also be able to use the cash value to cover your premiums.
With universal life insurance, you’ll likely have the option to adjust your premium and death benefit to suit your needs and financial situation.
When you die, your beneficiaries will receive a death benefit equal to the face value of your policy. You could have the choice of multiple beneficiaries, and decide how you’d like the money to be allocated between each.
Pros and cons of universal life insurance
Pros
Lifelong coverage. Your policy stays in force for your entire life, as long as you pay your premiums.
Cash value growth. A portion of your premium goes into an account that earns interest over time.
Flexible premiums. This policy usually allows you to change your premium and coverage amount — making it ideal for those who foresee income fluctuations or major life changes.
Tax advantages. The interest earned on the cash value portion is tax-deferred, and the death benefit paid out to your beneficiaries is tax-free.
Cons
Expensive. Universal life insurance is much more expensive than a temporary term life policy early on in life. However, it becomes much more cost effective as you get older.
Limit on returns. Your insurer may cap your cash value returns or how much you can invest based on tax laws, so ask about things like the “participation rate” or contribution limits before signing up
Requires monitoring. You’ll need to make sure your cash value doesn’t dip too low, or you could lose your coverage.
Not always the best investment. Interest rates tend to be conservative. If investing is your priority, you might be better off investing in a mutual fund, RRSP or TFSA.
Is universal life insurance right for me?
Universal life insurance has its perks, like flexible premiums and the ability to use your policy’s cash value to cover premiums later in life. But thanks to its investment component, it requires a higher risk tolerance and a more hands-on approach than term or whole life insurance.
Since it’s a complicated product, it’s best suited to those with complex financial needs. This may include parents with special needs children, or wealthy individuals who want to treat their life insurance policy as an estate planning tool after maxing out more traditional savings options.
Traditional universal life insurance vs. indexed universal life insurance
Indexed universal life insurance (IUL) differs from more traditional universal life insurance (UL) in one significant way: IUL allows you to tie your policy’s cash value to a market index, like the S&P 500.
The market index you attach your policy’s cash value to is often capped, which limits how much you can earn with IUL. If the S&P index is capped at 4%, it means your IUL cash value can earn up to 4% of what the S&P index earns only.
Traditional life insurance (UL)
Indexed universal life insurance (IUL)
Permanent
Yes
Yes
Builds cash value
Yes
Yes
Policy options — death benefit and premiums
Flexible
Flexible
Cash value rates
Fixed by provider
Tied to market index
Potential for investment growth
Conservative, stable
Assertive, fluctuating
What about variable universal life insurance?
This policy is a hybrid product with elements of variable and universal life insurance. The exact set of features of this hybrid policy will vary between companies. Some common distinctions made about variable universal life insurance policies include having flexible premiums, and a greater ability to diversify and personalize your investments.
While this product offers a high potential for return, it also comes with a higher degree of risk — making it best for high-income earners with prior investment experience.
Alternatives to universal life
If you’re interested in a permanent policy, consider whole life insurance. It offers similar benefits, like lifelong protection and the potential to build cash value. The cash value grows at a fixed rate, and the premiums stay the same for the life of the policy.
If you only need life insurance for a set period of time, look into term life insurance. This policy is cheaper, and provides protection for a specified term — like 10, 15, 20, 25 or 30 years or to a particular age, like 65. While it doesn’t have an investment component, it offers predictable premiums for the length of your term. If you die during the term, your beneficiaries will receive a death benefit. And if you outlive your policy, your coverage will expire.
Bottom line
Universal life insurance is a permanent policy that allows you to adjust your premiums and coverage amount and accumulate cash value. But it’s expensive, and you’ll need to stay on top of your policy’s available cash value to avoid losing your coverage.
Most likely. But double-check with your insurer about their application requirements, including whether you’ll need to undergo a medical exam or fill out a health questionnaire.
It depends on your needs. While it offers the potential to build cash value, most interest rates on these policies are conservative. Investing in an indexed universal life insurance policy may yield greater dividends, but in most cases, you’d be better off with in an RRSP.
Speak to a financial professional about finding investments that match your goals and risk tolerance.
If you’re a high net worth individual, you could consider purchasing a policy to build a tax-free inheritance for your heirs. When you die, they can then use the money to pay any taxes owing on the estate without having to sell off other assets.
Katia Iervasi is a lead writer and spokesperson at NerdWallet and a former editor at Finder, specializing in insurance. Her writing and analysis on life, disability and health insurance has been featured in The Washington Post, Forbes, Yahoo, Entrepreneur, Best Company and FT Advisor. She holds a BA in communication from Australia's Griffith University. See full bio
Chelsey Hurst is a publisher at Finder, specializing in banking and investments. She loves empowering people to avoid financial pitfalls and make better decisions with their money. Chelsey has a Bachelor of Science from Redeemer University, a Master of Science from McMaster University, and has won multiple awards for research communication. In her spare time, Chelsey enjoys cooking and taking long walks in nature. See full bio
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