Q&A - Answers to basic questions No. 27 to 30
27. Is this tax sheltering quality of universal life insurance really so important?
If you invest, seemingly small differences in annual returns produce huge differences over many years. If, for example, you want to accumulate $100,000 in 25 years, and you can achieve a 10% annual rate of return, you have to put aside $924 every year to achieve your goal. If your rate of return is just 8%, you have to put aside $1,266 every year. However, if the return is only 6%, then the needed amount in each year is $1,719.
There are different tax percentages charged on returns from various types of investments. On average, 30-40% is quite a conservative assumption, meaning that in a 25 year time frame one might easily end up with almost double ongoing saving need if he / she doesn't ensure with a tax shelter that the investment works only for him / her, and not partly for Revenue Canada.
28. What kinds of guarantees can one find in some insurance policies?
Guarantees make important parts of many insurance policies. A very basic thing is that you want to make sure that the coverage will stay in effect as long as you want it and as long as the costs of protection are being paid. However basic requirement, it is not the case with various group plans that can be cancelled (usually not on an individual basis though) at the insurance company's discretion. In practice, perhaps an even bigger danger is that coverage will cease with the termination of employment.
A related issue to cancelability is the question whether a term policy can be renewed. You can never be totally sure of whether you will want to renew a policy when it matures or not. Why not leave this option open then: Look for guaranteed renewable contracts!
Somewhat similar to renewability is the guaranteed additional future coverage option in some disability policies. It makes sure that you will be able to buy further coverage in the future even if your health have deteriorated by then, provided you have the earnings that warrant the coverage increase. What makes this option important is the effect of inflation and the close linkage of disability policies to current income. If you earn $3200 a month today, you cannot buy more than about $2400 monthly benefit. The amount may seem to be enough today, but 10-15 years from now your income will be much higher and the $2400 then will be far from enough; you may want to ensure the availability of some extra coverage by then, irrespective of your future health status.
Cost of protection is always an important issue. If you have a good premium today or promised for the future, you want to see that the company has no right to increase it.
Within the saving component of universal life insurance policies, one can find fixed rate investment options (just like a GIC), or sometimes guaranteed minimum rate of return on some non-guaranteed (therefore potentially more rewarding) investment options. Frequently, these policies offer guaranteed bonus return percentages on investments that fulfill certain criteria (such as size, duration, or achieved return).
Many people stick to their low return but fixed income investment because they are afraid of the stock markets' volatility. They give up on striving for significant returns rather than maybe having to wake up one day to see that their assets contracted significantly. For these people, and under the prevailing market conditions, segregated funds may be a solution. Segregated funds, that are becoming increasingly popular these days, and with very good reasons, offer important guarantees. Their issuers guarantee that after a certain time period (usually 10 years) the whole invested amount will be available, whatever happened on the stock markets in the meantime. It may not look like a very exciting guarantee, since even if there is a drop in the stock prices, 10 years should be long enough for the markets to fully recover. However, this guarantee of 100% is extended to cases when the owner dies at a time when stock prices are down. Since we cannot time our death, this guarantee is actually a strong one. It is even more so if we consider that the owner can reset the 10 year time period when the capital has achieved a higher than the original level. With such repeated "lock-in"s, one can effectively fight against the risk of 'dying at the wrong time', that is when the markets are down.
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29. Why are not all the universal life insurance polices equally good?
Certain universal life insurance policies can be wonderful, but one has to be careful with some others because
- the cost of pure insurance within various policies can be quite different. If it is high, there will remain less money in the investment part to work for you;
- the choice, historical performance and future earning potential of investment options available within various policies are far from equal;
- usually, there is some penalty to be paid (deducted from the account value) when you cancel your policy if you do it within a few years of getting the insurance; the details of levying this surrender charge vary from one company to the next;
- how the insurance company credits investment returns to policy owners can be quite different; as a consequence, comparing universal life policy illustrations from various companies needs expertise (you can click here to see details) and reliance on realistic and comparable assumptions.
30. I am concerned that my wealth can be curtailed in a lawsuit. Is my investment within a universal life insurance policy really creditor-proof?
Life insurance policies are (or at least can be) special assets: They can have a cash value which the owner can use freely, but also they can be irrevocably assigned to a beneficiary. If this beneficiary is a family member, usually creditors cannot get access to this asset even if you are faced with some liability you cannot pay from other assets. It's a serious issue, because huge liabilities can originate from professional or business practice, or even from a traffic accident where you were at fault.
Creditors can claim payment from the policy in a lawsuit, but if it can be shown that the irrevocable beneficiary designation was made in due course, and not as a desperate / cunning move to save money from a looming claim, then the creditors' attack will probably be unsuccessful.
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