There are many types of Universal Life insurance – guaranteed universal (or GUL), indexed universal (or IUL), and variable universal (or VUL). People who buy universal life insurance usually purchase these policies because they want lifelong protection, and they want their heirs to reap the benefits of a tax-free inheritance. Some of them include a cash value component that you can use to supplement retirement income. How do these policies work? If they’re permanent life insurance, how can they mature before you die? What happens then? Let’s take a look.
How does Universal Life Insurance Works
When you buy a universal life insurance policy, often times it’s until you turn a certain age—usually between 90 and 121, or for a certain number of years. You pay your premiums every month, and some of those go towards the cost of the insurance and the remaining goes towards building cash value. The younger you are, the more premiums will go towards to the cash value account since the insurance cost is less. Some people like to pay more initially, to build the cash value faster. That way, they figure they can use the cash value to pay the premiums later.
Use the calculator developed by Amplify below to calculate how much tax-free cash value you can withdraw from an IUL policy whenever you need it.
Universal Life Insurance Policy Matures
Let’s say you’re a 20-year old male and the year is 1960. Life expectancy is 66 for a man and 72 for a woman. You purchase an universal life insurance policy. The premiums aren’t bad, especially if the policy matures when you’re 85, rather than 90 or 121. Given the current life expectancy, you figure having the policy mature at age 85 should be sufficient.
Fast forward to 2020. You’re now 80 and you feel great. What happens in five years when your policy matures? Generally, you’ll receive a payment, equal to the policies’ death benefit, and then coverage ends. At maturity, the policy’s death benefit is always equal to the cash value account of the policy.
But what happens if you used some or almost all of the cash value to pay the premiums after you retired? As you withdraw from the cash value for any purposes or use the cash value to pay for the policy’s premiums to keep it in force, there is little left in the cash value account. During this process, the death benefits of the policy has been decreased accordingly. At maturity, the policy’s death benefit is always equal to its cash value and you will receive this death benefit, even it is now much less than what you originally bought.
If you withdraw or use all of the cash value of the policy and you don’t pay premiums anymore, the policy will be lapsed before maturity. This is the worst scenario because you will be required to pay back income tax on the difference between cash value that you have spent and the premiums that you paid.
In order to avoid such a scenario, it’s important to keep an eye on the cash value. It would also be a good idea to see if your policy offers a maturity extension provision.
Maturity Extension Provisions
A maturity extension provision keeps the policy in force after it matures. It’s usually available as a rider. This allows the death benefit to stay in force until the owner dies, thus leaving a tax-free inheritance as (probably) originally intended.
Luckily, most Universal life policies can be set up so that they mature when the owner is 121. Even the most optimistic actuarial tables will have most people dead by then.
If you don’t have a maturity extension rider and your insurance company won’t agree to keep the death benefit in force until you pass away, you must accept the payout, which is taxable. This is not what anyone purchasing a Universal life insurance policy was hoping for, so make sure you thoroughly understand your policy before deciding on a maturity date. If your goal is to leave money to your heirs, you should choose a maturation date of at least 100. Keep in mind people are living longer today, and life expectancy will probably continue to increase.