Most people opt for universal life insurance for the death benefit.
There are many people who aim to create a financial legacy for their children by getting themselves insured, because upon their death their spouse or children get a death benefit, if the premiums were all paid on time.
Let’s dive into the details.
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What is Universal Life Insurance?
A universal life insurance is a type of insurance which gives a permanent protection plan to the policyholder. Along with having an adjustable death benefit, policyholders also have a cash value in this plan.
One major feature of universal life insurance is that it has a flexible nature as compared to whole life insurance: adjustable premiums and death benefit. Flexible premiums mean that excess premium amounts can be added to the cash value, so you can skip paying premiums in the future without having to worry about the policy lapsing.
The Death Benefit
Of course, the death benefit is only granted to beneficiaries upon the death of the policyholder, but the cash value component can be used by them during their life too.
What is interesting is that universal life insurance has two options for death benefits, option A and option B- level death benefit and increasing death benefit. The policyholder then chooses whichever option works best for them.
Most commonly known as the level death benefit option in a universal life insurance policy, this is the type where the policy proceeds are the same throughout and are always equal to the death benefit. Here, the cash value is part of the death benefit and upon the death of the policyholder, beneficiaries will receive the death benefit AND the accumulated cash value.
Option B of the death benefit of universal life insurance is also referred to as increasing death benefit. Insurance protection amount remains the same of course, but the added cash value is basically the increase in the value of death benefit.
If your death benefit is smaller, your best bet is opting for an option B, because since there is a potential to make excess premium payments, your cash value grows at a commendable rate. Obviously growth of the cash value depends on the amount of premiums paid each month.
In short, high initial premiums and low initial death benefit leads to a faster growth of the cash value component. So the excess amount of premiums paid grows interest-free within the cash value.
Option B Death Benefit Explained
So we’ve gotten a slight overview of what a death benefit in option B looks like. Let’s explain it further by using real time examples with figures.
Just a recap: In option B, your insured amount remains the same, while your death benefit increases with accumulated cash value.
Greg purchases a universal life insurance policy of $500,000. Given the choice between option A and B, he chooses option B. Now over time he pays higher premiums which get accumulated into the cash value. Now his savings component has rounded up to $100,000.
When Greg dies, his beneficiaries will get a total of $600,000 as the death benefit and that too tax-free!
This is basically a major advantage of an increasing death benefit of universal life insurance; more cash value is grown over the years that your beneficiaries inherit.
One major disadvantage
In all of the pros of selecting option B, one major disadvantage is that if the policyholder dies early during the contract, beneficiaries will receive very less death benefit because of the initial low amount set.
The cash value requires a couple of years to mature, and with time the primary advantage of option B comes into force. However, in the unfortunate scenario that the policyholder dies during the early stages, the death payout will be significantly low as compared to if he had chosen option A.
A person who may have expected expenses in a few years like sending their kids off to college or paying for their child’s wedding, this type of death benefit option works best for such people.
This works out best for such a family because higher premiums are affordable when children are young; lower expenses, lower school fees and all of these determinants can be reasons for a family being able to afford higher premiums during early stages.
Of course, a portion of the cash value can be utilized during the lifetime of the policyholder, but the remaining can also be added with the death benefit granted to beneficiaries when the insured dies.
The Switch Option
What if you opted for option B of the death benefit and realized somewhere in the middle that it isn’t working out too well for you? That the premiums have suddenly become too expensive for you to pay and that you can’t afford them anymore? Or maybe, whatever major expense you had thought of isn’t there anymore.
Or vice versa. What if you want to switch from option A to B? Maybe you need a higher death benefit for your beneficiaries to soften their financial burden?
In all these reasons and scenarios, some policies give an option to the policyholder of easily switching to options and that too without additional charge.
If a policyholder switches from option A to B, the death benefit increases along with the net amount at risk, by the current amount of cash value.
Is Option B Better?
In some cases, yes.
If you want the cash value account to grow over time for an added death benefit, then yes, this type of death benefit option will work out best for you. It is also important to note that if there is an increase in death benefit at the end, it comes at the cost of paying high premiums too.
If you can afford to pay higher premiums throughout to keep growing your value at the end, go for it! A universal life policy comes with the option of flexibility that says that if you pay premiums upfront, you can skip further payments.
Since your beneficiaries get the whole death benefit PLUS any additional accumulation, and that too tax-free, choosing the death benefit under universal life option B is your safest bet!