What is universal life insurance?
Despite its complexities and cost, universal life insurance offers greater flexibility and some tax advantages. Here’s how it works.
Despite its complexities and cost, universal life insurance offers greater flexibility and some tax advantages. Here’s how it works.
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Among your different life insurance options, a universal life insurance policy is one of the most complex. It requires more involvement than both term and whole life insurance policies—so you can’t simply set it and forget it. And you have decisions to make regarding how much you pay, and how those premiums are used. You might be thinking: Life is short enough already, so why spend precious time managing a life insurance policy? Why not stick to a more straightforward solution, like term life insurance?
When the main objective is taking care of your loved ones after you’re gone, it pays to spend time figuring out how to care for them. That’s why you should familiarize yourself with the full slate of possibilities. For those looking for flexible premiums and the opportunity to accumulate wealth on a tax-deferred basis, universal life insurance can be a smart option. You may even be able to benefit from it during your lifetime. But due to their complexity and cost, these policies aren’t suited to everyone, so take the time to understand how they work.
Universal life insurance is a form of permanent life insurance, meaning it offers lifelong coverage as long as you keep making your payments. Unlike term life insurance, a universal policy does not expire at a certain age, nor after a predetermined number of years.
One of the most important features of universal life insurance is the inclusion of an investment account, allowing policyholders to invest and accumulate wealth on a tax-deferred basis. Think of universal life insurance as a policy and investment account in one: a portion of your premiums is used to cover the cost of your insurance, and the remaining funds are yours to invest.
Here’s how it works: You make regular payments into your policy’s investment account. Each month, the insurer deducts your insurance premiums and policy fees from the account. Depending on the investment you choose, the rate of return on the leftover funds can be guaranteed or not. The interest earned on your investments is not taxed (up to a certain amount outlined by the government) as long as the money stays in the account.
Depending on your policy, you may be able to make withdrawals or take out an interest-bearing loan against the cash value of your policy. The cash value refers to the cash amount that accumulates within your policy, and it is distinct from the death benefit. If you cancel a permanent life insurance policy, you get its cash value. However, in most cases, the cash value does not typically pass to your beneficiaries—only the death benefit does.
Universal life insurance is more complex than other forms of life insurance. The premiums also tend to be higher than with term life insurance; they are generally more comparable to those for whole life insurance, but can fluctuate—unlike whole life premiums. And depending on how the investment portion of the policy performs, the cash value is not guaranteed. For these reasons, a universal insurance plan is not a good fit for everyone.
However, there are benefits for those prepared to spend the time to understand the nuances of universal life insurance:
Even if you know you want permanent life insurance, you’ll still have to pick between universal life insurance and whole life insurance. Here are some of the key differences:
There are distinct advantages to universal life insurance, but because you’re paying to be covered for life (as opposed to a set amount of time, like with term life insurance), the premiums can be costly. It’s also more complex and requires more involvement from the policy holder.
That said, universal life insurance can serve as a wealth-building tool for someone who’s comfortable managing investments, and has the time and desire to be more involved. Generally speaking, universal life insurance is best for high-income earners who can take advantage of the tax benefits.
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Total fees on Universal Life Insurance investments are very high making them unattraactive!
Universal life and whole life insurance are only great for the insurance companies! They keep all your investments when you die and only pay out the face value of your insurance to your family or your benefactor. If you want to borrow your own gains on your policy you have to pay the insurance company interest. Always buy term and invest the difference yourself. Buying term is also more affordable and you can great much more insurance for the same amount of money, you should always have at least 10 times your annual salary in insurance, universal or whole life insurance makes this totally unattainable. I can’t believe Money Sense would promote something that isn’t a great investment option for anyone.
I think its worth pointing out that universal life insurance policies have more limited investment opportunities compared to if one were to invest the same money outside of the policy. Typically UL investment options are more costly mutual funds compared to ETFs for example. Secondly, many UL policies have an annual additional investment charge on top of the MER, which is often not advertised when the advisor sells the policy.
I would have to agree with Carol’s comments and wonder why MoneySense would have this article without showing in detail the cost of this product. Please do your readers a favor and compare it in detail to buying term and investing the rest. The MER/fees wipe out most of the gains for the average person. And you get none of the benefits of the “investment” side if you pass away. I suggest reading Dave Ramsay (US financial guy) on you youtube or google his sight for a different perspective. Although US based it is the same issues. He is very vocal on this topic. But insurance for insurance and buy investments for wealth growth….simple
Wow, only benefits and no drawbacks! Seems like an ad for UL.
The fees are massive on the investment products associated with universal life. The best answer is usually ‘buy term and invest the rest’.