If you own a universal life policy, you undoubtedly were attracted to the thought of a permanent life insurance policy that builds cash value but was much less expensive than whole life insurance. The way universal life insurance works is that part of the premium goes to fund the death benefit, and part of the premium is invested and creates a cash value account. The strength of the investments is what fund this account.
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Flexible Premiums Advantage in Universal Life Insurance
A major selling point of universal life insurance is that it can offer flexible premiums. You can change how often you pay, how much you pay, and eventually you can have the cash value pay the premiums. This flexibility allows you to structure the policy so that you either maximize the cash value or the death benefit, depending on your goals. Different goals, either maximizing cash value or death benefit, can be served by different universal life insurance products. See more details below.
Universal life insurance policies are generally designed in a way so that the cash value account is equal to the death benefits when it matures. At maturity, the insurance company gets the cash value if there’s any left, so either way, it’s ideal if there’s no money in the cash value account when you pass on.
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Maximizing Cash Value Account with Indexed Universal Life Insurance Policy
If your goal is to use the funds to supplement your retirement income, you should maximize the cash value. The money grows in the account and you can withdraw from it tax-free. In order to do this, early in the policy you should pay as high a premium as you can, beyond what is required to fund the policy, so it can go into the cash value account.
This strategy allows you to withdraw a certain amount each month, tax-free, to supplement your retirement funds. Just be sure to work with a good advisor who can help you choose and design the right policy, which, if funded properly, will allow you to withdraw from it to support your goals well.
Indexed universal life insurance, or IUL, is designed to help you maximize the cash value account in the policy by benchmarking the interest rate earned with the performance of indexes such as S&P 500. The IUL policy is usually designed in a way that most of the premiums is used to grow the cash value account and a small portion of premium is used to pay for the cost of insurance. As a result, the death benefit in an IUL policy for the retirement income purposes is typically small.
Essentially, the cash value account in a IUL policy performs like an investment account investing in index funds. Even better, this investment account never loses money even if the index has a bad year thanks to the guaranteed floor rate of 0-2%, varying by the insurance companies and their products. It also comes with a cap rate, from 8-12%. In addition, when you withdraw money from the cash value account, as long as the policy is still in force, you never have to pay any income tax.
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It’s also important not to allow the policy to lapse, so remember to pay the premiums or subtract the amount from the cash value. Keep in mind, cost of insurance goes up as you age, and if you depend on the cash value to pay them, be sure to have the policy is designed in such a way from the beginning.
Maximizing Death Benefit with Guaranteed Universal Life Insurance Policy
If, on the other hand, your goal is to leave a tax-free benefit to your heirs, you should transfer the cash value in the policy to leave a larger death benefit. Usually, if you call your insurance company, you can increase the death benefit for the amount in the cash value account.
The best policy for this purpose is guaranteed universal life insurance, or GUL. GUL also offers a cash value account in the policy. However, it doesn’t really build much cash value since each dollar of your premiums is utilized to maximize the death benefit that your beneficiary will receive.
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You’re going to want to fund your policy with the minimum amount possible; just enough to fund the insurance cost for the death benefit you want and keep it in force, if your strategy is to leave a tax-free lump sum for your heirs.
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Last Thoughts
Either strategy is acceptable, depending on what your goals are. The main things to remember are not to let the policy lapse, and by the time you die, ideally the cash value should be zero. The insurance company gets to keep that money, so you might as well either withdraw it or put it into the death benefit.