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Is universal life insurance right for you?

Term life insurance is affordable, but it expires after a certain time. Whole life insurance often is more expensive because it never expires. Looking for something in between? Universal life insurance might be for you.

First introduced in 1979 by E.F. Hutton Life Insurance Co., universal life insurance is one of the most flexible life insurance options.

“It’s a sound option to consider if you want the option of variable premiums or to adjust your coverage as your needs change,” says Edward Graves, associate professor of insurance at The American College in Bryn Mawr, Pa.

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Here’s what you need to know to decide whether universal is the best coverage for you.

Sizing up your options

The first step in deciding on a type of life insurance is understanding your options. There are three basic types of life insurance policies:

Term life. The least expensive life insurance option, term life is the most basic and inflexible. Coverage begins the year you apply and ends at a set time, usually 20 or 30 years down the road. You pay set annual premiums and don’t receive dividends.

Whole life. These policies last the rest of your life, rather than for a predetermined number of years. They have a set premium that you must pay on time, and a guaranteed cash value because a portion of your premiums goes into a savings account. That savings account grows, as your insurer also pays dividends.

The most expensive of life insurance options, whole life policies typically cost about eight times more than term policies, largely because of the dividends that policyholders receive based on the insurer's earnings, says Alan N. Canton, owner of A.N. Canton Insurance Services in Fair Oaks, Calif.

Universal life. With universal life (a variation of whole life insurance), you have the option of varying the premium amount (or even skipping premium payments), changing the coverage amount and adjusting the number of years you pay. Canton says this coverage costs about four times as much as term life insurance.

The pros of universal coverage

Unlike term and whole life policy premiums, which are set by the insurance company, you set your premium if you have a universal life insurance policy.

Every time you pay your premium, the insurance company deducts a fee to cover the company’s expenses. The remainder of your premium is added to the policy’s cash account and is invested on your behalf by the insurer. That cash account grows over time, and the cash value can increase.

“The first year’s premium is the only fixed premium,” Graves says. “After the first year, the policy owner can choose the premium amount, as long as it is enough to keep the policy in effect.”

All that’s required to keep the policy in effect is enough cash value to cover two months’ worth of charges for the insurance company to manage the policy. “If the cash value drops below that required minimum, the policy may terminate,” Graves says.

If your policy has a cash surplus, on the other hand, you’ll earn interest -- generally at a money-market rate, according to the Insurance Information Institute.

The flexibility of universal life means that the policy can be funded minimally and work much like a term life insurance policy, Graves says. If you opt to pay more in premiums, it will develop cash value like a whole life policy.

With universal life, “if there is enough money in your fund, you can skip a premium or a year of premiums and make them up later,” Canton says. “You can’t do that with whole life or term life.”

Another benefit of universal life is that you can lower the amount of the policy (the amount it pays when you die) to reduce your premiums or trim the number of years you pay into it. For instance, Canton says, many people prefer to buy a policy with a large death benefit while their kids are young. Once their kids are grown and not as much financial protection is needed, the benefit amount -- and the premium -- can be decreased.

Shawn Hilario, a senior product consultant for life insurance at The Hartford, says it’s possible to add a chronic care rider to a term life policy. Should the insured become chronically ill, he or she will be able to get the death benefit early. Hilario says this rider costs an average of 10 percent of the policy’s death benefit. There’s no limit on how the money is used, and it’s tax-free.

“You can pay a family member or friend to care for you at your home, remodel your home to accommodate your health needs or pay bills,” Hilario says. “The money is yours to use as you see fit.”

The cons of universal coverage

Receiving interest from a universal life insurance policy and maintaining a comfortable cash cushion are not guaranteed.

“The policy’s value can go up or down depending on how the life insurance company invests your money,” Canton says.

Also, the amount required to keep the policy in effect can fluctuate. If the life insurance company takes a financial hit -- as many have amid the rocky economy -- you may be forced to fork over more money each year to keep the policy going.

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