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What is Universal Life Insurance? Understanding Option A vs Option B

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Universal Life insurance may be one of the best possible policies you can purchase, but many people opt for the more expensive guaranteed whole life or for the less suitable Term insurance just because they don’t’ understand the nature of a universal policy.

To put it simply, a universal policy has two components—the life insurance component and a savings or “accumulation” component. Unlike the whole life in which the premium directly pays the cost of insurance, the premium paid for a universal policy is deposited into a savings account which accumulates interest. Out of this fund, the cost of insurance and fees are paid. Because the COI is always paid from the accumulation fund, there is no “required” premium once the cash has build up enough to create an accumulation side—something that happens within just a few months in a properly structured policy. You do, however, want to continue to pay the premium because it is the build up of cash value that can eventually get you to the point where you can stop payments and still have enough of an accumulation for the insurance to function as if it were a “paid up” policy. (Note: the term “paid-up” is not actually used in reference to a universal policy. Rather the end result or concept is similar because of the way the accumulation fund works.

Option A, Option B Defined
When an insured under a universal policy dies, the beneficiary gets the face value, whatever that is. If you “cash in” the policy early, you get the cash value. In a properly funded universal the cash value can exceed the face value, forcing an increase in the face value in order to prevent the policy from becoming a modified endowment contract (a taxable benefit). This brings a common question: “If I die, does the beneficiary get both the face value and the cash value?” The answer is “yes,” but the actual amount of money received will depend on whether the policy is an option A or an option B. Option A is the most common and the least expensive. The face value will remain unchanged unless the cash value begins to exceed it. The benefit actually includes the cash. Thus as the cash value grows, the company is actually at risk for less. 

Option B is more costly because the death benefit or face value is paid in addition to the cash value. On an illustration, you will see the death benefit increasing every year. The actual face value of the policy is unchanged. That is, a $50,000 death benefit is still $50,000, and your cost of insurance is based on $50,000. However, the amount that is shown will be the face value plus the cash value each year. Due to the increase in premium necessary to accomplish this, most people select option A.

The most common types of universal policies sold today are “fixed.” That means that while interest rates can and do change, and you have the freedom to make changes to your policy, the company will guarantee that you will not lose value due to fluctuations in the stock market. Some companies do, however, offer a variable universal life. In this type, the company will usually guarantee a minimum death benefit as long as a certain premium is paid, but the cash accumulation account is actually invested in a variety of available funds. It is thus possible to grow the accumulation side more quickly than in a fixed product. It is also possible to lose the accumulation fund if the market has a down turn. You should not use a variable universal life unless you either understand the market yourself or have a broker whom you trust to manage it correctly. If you are interested in a variable universal, you will need to seek out a brokerage such as Vanguard or Edward Jones as the person who sells you the product must have a securities license. Typically, insurance companies do not sell variable products and insurance agents are not required to have securities registrations.  A few companies, however, John Hancock being one, are able to both explain and offer the benefits of both types of policies.

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