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Universal life policies combine term insurance with a tax-sheltered investment account. The term insurance provides the death benefits, while the investment account pays interest, usually at competitive money market account rates. The difference between whole life and universal life is that the universal life premium is unbundled: The portion of the premium paid for death protection and the portion paid into the investment account are identified separately. This contrasts with whole life, where the premium paid goes toward a policy with a stated face value amount of coverage, as well as a cash value that accumulates according to a specified fixed schedule. When a premium is paid for a universal life policy, it is split up. Part of the premium goes to pay administrative fees, while the remainder is put into the cash value, or investment account. There the money will grow at a certain rate. This rate is periodically revised due to fluctuations with market yields, but it will be guaranteed to be at least a certain amount (such as three percent). Then, each month, one month’s cost of insurance is withdrawn from the investment account, which is then used to purchase the required death protect tion. As long as there is enough money in the investment account to purchase death protection, the policy will remain in force. However, if this account should grow to an abnormally large amount, the amount of insurance protection will need to be increased. This is so the account can retain its tax-deferred growth status. The IRS requires that the death benefits in a universal life policy must always exceed the cash value by a specified amount. This raises an important question. Because the premium is split, and the investment account is separate, is this actually whole life? Since the cost of insurance is subtracted from the cash value, the answer is yes. However, the cash value accumulates because of interest credited to the account. According to current tax laws, as long as the total value of the investment account is less than the total amount of premiums paid, the growth of the investment account will be taxdeferred. However, if a policy is canceled and the cash value is returned to the policyholder, and the cash value is greater than the amount of total premiums paid, the gain will be taxed. But, like other types of insurance policies, death benefits are received tax-free and the cash value grows on a tax-deferred basis. Universal life policies have two types of death protection: Option A and Option B. First, Option A provides level death protection. When the cash value increases, the amount of pure insurance protection decreases. The second choice provides a specified death protection plus the appreciated cash value. With Option B, the death benefit varies with the rate of earnings in the investment account. It will also increase along with the growing cash value.
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