One of the most misunderstood features of universal life insurances is the difference and significance between option A versus option B. Flexibility is the hallmark of universal life insurance. But with flexibility comes confusion and uncertainty.
Parents want to make confident and informed choices about how to protect and provide for their children. The difference in the application may be most important. Understand the definitions and implications of universal life insurance option A versus option B by looking at:
- Option A Definition
- Option B Definition
- Implications to Excess Premiums
Universal Life Insurance Option A
Universal life insurance option A pays the face amount of the policy when the insured dies. The death benefit amount remains level throughout the life of the contract. As cash value accumulates inside the policy, the amount at risk to the carrier decreases. If the policyholder dies early in the contract lifetime the insurance carrier must finance most of the death benefit.
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Option A Advantages
The primary advantage of option A is the lower premium cost. Option A is most widely purchased because it provides the highest death benefits relative to the premium dollars spent on a cash value policy.
The target purchaser is an individual who wants some form of permanent coverage, with a higher death benefit, and lesser concern about cash accumulation. The target buy may be in midlife with less time to accumulate cash value, but with a need for a permanent policy.
Option A Disadvantages
The death benefit will not increase under option A unless excess premiums are paid. The amount of excess premiums that can be paid under option A is also more limited. Excess premiums are covered in more detail below and may represent the biggest disadvantage of option A.
Universal Life Insurance Option B
Under universal life insurance option B, the policy proceeds increase over time and are equal to the cash value plus the death benefit. The amount at risk to the carrier is always equal to the policy death benefit.
As cash value grows inside the contract the stated death benefit must also increase in order to comply with DEFRA guidelines (Deficit Reduction Act of 1984). These guidelines are designed to limit the amount of excess premiums a policyholder can pay into the policy, and gain from the tax-favored treatment of life insurance proceeds.
Option B Advantages
The primary advantage of universal life insurance option B is that cash values grow more quickly over time and the higher level of excess premium contributions allowed by the IRS.
The cash values accumulate more quickly because of the higher initial premiums and lower initial death benefit. Since the premiums are higher and the death benefit is initially lower, a greater portion of the premium is added to the policy cash value, which then grows interest-free inside the contract.
Excess premium payment options are far laxer under option B. The death benefit grows over time to allow these additional premium payments, and may be the biggest advantage to Option B. Read why below.
The target buyer of option B is a young family with a goal to accumulate tax-favored cash values. The family can cover one or both parents, and parents will often purchase coverage for their young children. When purchasing for children, more of the policy premium is directed towards cash value.
Option B Disadvantages
The higher premium amount coupled with the lower initial death benefit amounts are the biggest disadvantage to universal life insurance option B. If a policyholder were to die early on in the contract, the amount paid to the beneficiaries would be far smaller than if Option A were selected.
Excess premiums are an additional premium the policyholder can elect to contribute to a policy. Excess premium payments result in increase policy cash value and contribute to policy stability as interest rates fluctuate.
Expanded ability to contribute excess premiums can be the deciding factor when comparing universal life insurance option A versus Option B. Option B allows for greater tax-favored cash accumulation. This advantage is most pronounced when considering college savings.
People leaning towards option A may find term life to be a more suitable comparison.