By Dr. James M. Dahle, WCI Founder
As a physician, your attention is on your patients’ health and well-being. You should also be thinking about your own health, and as unpleasant as it might be to ponder, your family’s financial health in the event of your death. If you are your family’s breadwinner, it is critical to ensure your loved ones are covered after your passing. The most common and usually smartest way to deal with that is via term life insurance. However, physicians are sometimes offered a universal life insurance policy and wonder if they should use that instead of or in addition to a term life policy.
What Is Universal Life Insurance and How Does It Work?
Universal life insurance, like its cousin whole life insurance, is a permanent or life-long insurance policy that does not expire after any certain term, like term life insurance. As you would expect, you get coverage over the course of your life as long as you pay your premiums and fulfill any other obligations to keep your policy active. When you die, your universal life insurance policy death benefit is paid out to your beneficiaries. The policy also accumulates cash value as it goes along, just like whole life insurance. You can borrow against this cash value tax-free but not interest-free. Naturally, these benefits do not come free and universal life insurance, like other permanent life insurance policies, costs a lot more than a term life insurance policy for the same death benefit.
The benefit of universal life insurance over whole life insurance is its flexibility. While it provides fewer guarantees than whole life insurance, it can be structured in a lot more creative ways, for better and for worse. For example, universal life insurance policies generally allow you to increase or decrease your premiums within certain limits. Naturally, there are downsides to lowering your premiums too much in that you can negatively impact the policy’s cash value growth and the size of the death benefit if you make minimum payments for too long.
So how does universal life insurance work?
Every time you pay your universal life insurance policy, part of the payment goes toward the cost of the insurance, basically providing the death benefit. The rest goes toward the policy cash value. Think of the actual life insurance policy inside the universal life wrapper as an annually renewable term contract. It goes up in cost every year. While very cheap when you are young and healthy, it is very expensive in your later years. However, theoretically, the earnings on the cash value portion of the policy can more than make up for the additional cost of the insurance later on.
Universal life policies can be broken down into multiple categories depending on how that cash value is invested in the meantime.
Types of Universal Life Insurance
There are a number of commonly used types of universal life insurance.
Straight Universal Life
With a “standard” (if there is such a thing) universal life policy, the cash value simply earns interest. Typically the interest is along the same lines as current money market rates, according to the Insurance Information Institute. While the idea of earning interest as you provide your loved ones with a safety net sounds great, remember the market can fluctuate, which could ultimately decrease that interest as well.
Guaranteed Universal Life
The policy can also be structured NOT to accumulate any cash value. In fact, a universal life policy can be the cheapest way to provide a guaranteed lifelong death benefit. These policies are called Guaranteed Universal Life (GUL) policies. Think of it as a lifelong, level-premium term life policy. Whenever you die, whether at 30 or 90, it will pay the death benefit. These policies cost about half as much as a whole life policy. Keep in mind, however, that with a whole life policy, the death benefit generally goes up a little each year at about the rate of inflation. The death benefit remains level with a GUL policy.
Index Universal Life
Index Universal Life Insurance policies (IULs) are among the most complex life insurance policies out there. Rather than crediting the cash value based on a money market-like interest rate, the cash value is credited based partially on how equities (i.e. stocks) performed that year. The formulas for how this actually occurs are complex and under the control of the insurance company. However, insurance agents often sell these policies to clients who want stock-like returns with none of the risk, i.e. eating your cake and getting to keep it too. The main problem is they don't get stock-like returns. In the long run, these policies tend to have returns far more similar to those of straight universal life or whole life insurance policies (i.e. 2%-5% per year for policies held for decades). In many ways, these policies are products designed to be sold, not bought, and are not generally recommended by anyone who does not benefit from their sale.
Variable Universal Life
Variable Universal Life (VUL) policies are also generally products designed to be sold rather than bought. However, they do have one potential niche use as an additional retirement account that might make sense for a few people. With a VUL policy, the cash value is invested into mutual-fund like subaccounts. These subaccounts not only earn money when the underlying investments do well but also (unlike IUL) lose money when the investments do poorly. Like any other permanent life insurance policy, the cash value grows in a tax-protected environment. Theoretically over the long run, a VUL will be the best performing of the universal life policies. However, many VULs are littered with high fees, high insurance costs, and lousy investment subaccounts. So you end up with lousy insurance and a lousy investment. If you choose to use one of these as an additional retirement account, make sure it has low fees and top-notch investments. The key to deciding whether to use a VUL as a retirement account is whether the tax savings can overcome the additional costs of the insurance wrapper.
What Is the Biggest Risk with Universal Life Insurance?
The main problem with a universal life policy is that the insurance gets very expensive in your older years. This can eat up the entire cash value and actually require the owner of the policy to pay in large additional premiums in old age to keep the policy from imploding and being canceled/surrendered. When a policy is surrendered, the owner must pay taxes on all of the gains in the policy at ordinary income tax rates, even if there is no cash value left! So the worst-case scenario with a poorly managed universal life policy is that there'd be no death benefit for the heirs AND the owner is faced with the unpalatable choice of using limited funds to make additional premium payments or facing a huge tax bomb in their golden years. This can occur if the policy owner made the premiums too small, if the investments inside the policy performed poorly, or if the owner borrowed too much against the policy.
The easiest way to minimize this risk is to decrease the death benefit as you go along. The smaller the death benefit, the smaller the premiums, even in old age. Naturally, this makes a universal life policy a poor choice for someone who actually needs or wants to pay out a large death benefit should they die at a relatively old age. Whole life or a GUL policy is probably a better choice.
Who Should Buy Universal Life Insurance?
Do you have loved ones who depend on you financially? If so, you should have a life insurance policy, even if it's not a universal one (a term-life policy is great for most investors). However, a universal life insurance policy may be useful for someone with a unique financial need, whether a guaranteed life-long death benefit or another source of retirement funds.
While the policy can be used for long-term savings goals, informed investors generally regret mixing insurance and investing in this way. Universal life insurance is generally considered to be inferior to whole life insurance when it comes to Bank on Yourself/Infinite Banking systems. Certainly, there is no reason to fund any type of permanent life insurance policy for retirement savings before maxing out all available retirement accounts.
What Does Life Insurance Cover and How Much Life Insurance Coverage Do Physicians Need?
Life insurance provides a death benefit to your heirs either for your entire life (permanent policies like universal life) or for a set period of time (term life policies). This insurance provides financial relief to your beneficiaries in the event of your death. Universal life policies do offer the flexibility to raise or lower the death benefit to suit your current needs—a higher death benefit creates a higher premium and vice versa.
How much life insurance coverage physicians need can depend on where they are in their careers, the size of their nest egg, and who else depends on their income. Most young doctors with an insurance need wisely buy a policy with a $2 million-$5 million death benefit. Residency is a great time to purchase a life insurance policy because you’re likely young and healthy enough to secure a lower premium. However, residents don't make much money and even a $2 million-$5 million term life insurance policy may be out of reach. It'd be best to get something in place, even if it is just a $500,000 to $1 million policy and then hopefully purchase some more upon completing training.
How Much Does Universal Life Insurance Cost?
It depends. Yes, that’s the last answer anyone wants to hear when it comes to how much something costs, but with universal life insurance, it’s the truth. Your age, health status, and the insurer are among the factors that will determine your universal life insurance premium. For example, a $500,000 universal life insurance policy could cost a 30-year-old male $1,722 annually ($1,499 for a 30-year-old female) vs. $6,299 annually for a 60-year-old female ($7,351 for a male). That is approximately four times the cost of a term life policy.
How much you’re willing to spend also plays a part. As previously mentioned, the higher the death benefit you want for your family, the more you’ll pay for your premium.
Pros and Cons of Universal Life Insurance
There will be plusses and minuses to whatever life insurance policy you select. Here are some things to consider when you look at universal life insurance.
Pros of Universal Life Insurance
Here are some of the pros of universal life insurance:
- Flexibility: You can change how much and how often you pay your universal life insurance policy premium. You can also increase or decrease your policy’s death benefit.
- Interest: The funds in the cash value portion of your policy will earn interest based on the type of investment inside the universal life insurance wrapper. This gives you a chance to earn more while ensuring your loved ones are covered financially in the event of your death.
- Cash Access: A universal life insurance policy allows you to borrow against (tax-free but not interest-free) or surrender the policy (interest-free but not tax-free if there are gains) in order to access the cash value.
- Life-Long Death Benefit: If you want a death benefit even if you die at an old age, you will need a permanent policy, not a term policy.
Cons of Universal Life Insurance
- Increased Expense: Term life is the cheapest way to provide a death benefit to heirs during your working years.
- Added Responsibility: The flexibility that comes with a universal life insurance policy means it’s not a “set it and forget it” situation. If you opt to not pay or underpay during lean times, you might find yourself having to play catchup later on to maintain your coverage.
- Market Volatility: It’s great that you can earn interest on a straight universal life insurance policy—especially when rates are high. When they fall, however, so does your account value. IUL and especially VUL policies provide even more volatility. You may want to consider a different type of life insurance if you cannot stomach the inevitable lows.
Universal Life Insurance Riders Doctors Should Add
Life insurance riders are extra benefits you can purchase and add to your policy. Universal life insurance riders let you customize your policy and create more protection based on you and your family’s needs.
While not every life insurance rider might be worth it for physicians, here are a few to consider:
- Waiver of Premium Rider: This would allow you to forgo your insurance premium payments in the event you become critically ill, injured, or disabled and could not earn income. If you return to work, your premium would be reinstated. Generally, disability insurance is a better way to provide this protection
- Accelerated Death Benefit Rider: This special provision would gain you access to a part of your policy’s death benefits while you’re still alive if you were diagnosed with a terminal illness.
- Long-Term Care Rider: If you prefer to tie your long-term care coverage to your life insurance policy, you could with this rider. The rider provides accelerated payouts from the death benefit to help with long-term care for daily activities like bathing, eating, or getting around your home.
- Accidental Death and Dismemberment Coverage Rider: This provides an extra benefit in the event you suffered an accidental death or dismemberment. The rider could potentially pay out twice the initial benefit. Note that most people do not die from accidents (they die from illnesses), but if you feel you are more likely than most to do so, you might consider this rider.
When Should Doctors Buy Universal Insurance?
Universal life, if purchased at all, should generally be purchased at mid-career or later. While the insurance will cost more than if you had bought it at a younger age (and you might not be eligible to buy it at all), you will be in a far better position to pay the high premiums it requires. Doctors who buy universal life policies should make sure they either have a true need for a permanent death benefit or have no better use for their money, including paying off student loans, paying off mortgages, maxing out retirement accounts, or even investing in tax-efficient investments such as real estate or index funds in a non-qualified account.
How to Buy Universal Life Insurance
Purchasing universal life insurance involves a lengthier process than other products. Once you’ve decided it’s the right life insurance policy for you, you should enlist the aid of an independent insurance agent who can sell you a policy from any company. You may even want to use two or three agents since this is a big financial commitment and you want to make sure you get multiple opinions. It is best if these agents are experienced at selling cash value life insurance, but you need to know what you want BEFORE you go to see the agents, lest you end up with a high-commission product designed to be sold, not bought.
You’ll have to complete an application that will ask for typical information like your name, address, and annual income. Since this is a life insurance policy, companies will also inquire about life factors, like your age, height, weight, medical conditions, and lifestyle habits.
Your medical exam results will determine if you are eligible for a universal life insurance policy. Insurers will ask about your and your family’s medical history. The exam will mirror a physical—a medical worker will record your blood pressure and pulse and collect a blood and urine sample. While some insurers won’t request a medical exam, you might have to pay a higher premium for those policies.
Lastly, if approved, you’ll finalize your policy, sign the necessary paperwork, name a beneficiary (or beneficiaries), and make your initial premium payment. If your application is denied due to a health factor, you can take steps to change your lifestyle and reapply.
How and When to Cancel Your Universal Life Policy
Universal life policies, like other permanent policies, are designed to be held until death. If you realize you bought something you should not have, get term life insurance in place and then cancel the policy. The poor returns of permanent policies are heavily front-loaded, however, so it often makes sense to keep a policy you have already had for a decade or two, even if you should not have purchased it in the first place. If you do surrender a policy, you will owe ordinary income taxes on any cash value that is above and beyond the total of premiums paid. It often takes a decade or more to break even on a policy though, so there is often no tax bill at all to surrendering a policy.
Prior to surrendering a universal life policy you have owned for years, consider simply restructuring it. Lowering the death benefit substantially may improve investment performance, and it will certainly lower the cost of any ongoing premiums. This flexibility is the main benefit of a universal life policy, so take advantage.
How to Cancel Your Life Insurance Policy
Call your insurance provider once you decide that you no longer need your universal life insurance policy. They can lay out your options. These options include cashing out your policy—you could face penalties and fees if you do so early. Every insurer has a different definition of “early,” however. Your interest earnings are also taxed as income if you cash out.
Another cancellation option is to let your policy lapse (not pay your next premium). This might not be wise as insurers could use the cash value you’ve accumulated to pay your unpaid premiums. Find out if the company does this, and if so, cash out and cancel rather than let the cash run out.
A reduced paid-up option could allow you to pay fewer cancellation fees. In this scenario, you stop paying your premium, but your death benefit is decreased. The payout might be less, but you won’t face as severe penalties as you would from simply cashing out or letting your policy lapse.
Where to Buy Universal Life Insurance
There’s no shortage of agents willing to sell you a universal life insurance policy. We suggest you begin your search with the WCI list of recommended insurance agents. However, recognize that since most white coat investors neither need nor want universal life policies, these agents typically sell term life and disability policies, and other agents may have more expertise with universal and other permanent life policies.
Do you or have you used universal life insurance? What are your thoughts about it? Have you utilized the flexibility of making premium payments? Comment below!