Why is Universal Life so attractive? Are there any weaknesses as well?
Universal life insurance plans (ULs) can also be structured as what is referred to as leveraged life insurance policies or insurance retirement plans (IRPs). As you have probably learnt, these policies combine insurance protection with investments. Their applications are built on one or more of the following strong features / advantages:
- They are flexible. There is quite a wide range of premiums that can be paid into the policy every year. If enough cash reserve has accumulated in the policy, payment can even be skipped or finished.
- The owner of the policy is in control of what is happening with his/her money. Unlike in so-called 'participating whole life' policies, insurance costs and administration fees can be fully guaranteed for life. The cost of pure protection is clearly separated form the investment part, and it makes the policy transparent for the owner. The owner can move money between various investment options.
- Reserves in the policy can grow in a tax-deferred way that is hardly available elsewhere, apart from RRSPs.
- If the investment is paid out at death, it will be part of the tax-free death benefit; that is the tax-deferred accumulation will actually become tax-free. This cannot happen with regular RRSPs, since tax is levied on either withdrawals or inheritance from them.
- Premium can be paid from that tax-deferred accumulation directly. It means practically a very substantial saving on the cost of the policy.
- Investment bonus is paid to policies after a certain number of years and/or above certain level of returns or amounts of money invested. This accumulating bonuses alone can, in certain cases, pay the cost of insurance after some time.
- The choice of available options for investments in universal life policies is quite wide, and according to historic evidence these investments are really competitive with many other popular options.
- The creditor-proof nature of investment within an insurance policy adds to the attractiveness; should claims arise from professional practice, traffic accident, being duped, or whatever reason, the investment (together with the tax-free face amount at her death) will stay within the possession of herself and her family.
- With some policies, one can buy very competitive disability, critical illness, or long term care insurance riders, paid in a most tax-effective way, that is from the reserves accumulating tax-free.
- Provided there is enough money accumulating in the policy, inadvertent lapse of the policy, that can be a real danger with term or T100 (pure protection permanent) policies (because of, e.g., sickness, travel, personal/financial crisis, or just plain forgetfulness), is averted.
- The most typical, though not only, application of UL is when in retirement (tax free) money is borrowed form banks and the policy is used as a collateral, resulting in a very tax-effective way of living off savings during many years of retirement.
There are, of course, some weaknesses as well. In total, these do not invalidate the substantial benefit these policies provide.
- Just like with any other life insurance policies, one has to calculate 2% provincial tax on every premium. Although it is already included in the premiums shown by insurance companies, it would be unfair to forget about this when one compares investments within and outside of universal life policies.
- Revenue Canada does not provide an unlimited free ride. There is a maximum limit on the invested amounts that can grow in a tax-deferred way. If one wants to raise that limit, one has to increase the face amount of the policy even if he/she is not really interested in the basic protection function of the policy.
- Dealing with this kind of protection demands more expertise than dealing with term insurance, since not all the UL policies that are offered are qualitatively the same. Wording of UL policies should be carefully examined, due to their complexity and may not be easily understood by the uninitiated. Click here for further details on how to evaluate various universal life insurance options.