Universal Life Insurance

Background:

Starting in 1980’s universal life insurance started to replace whole life insurance as the preferred type of permanent insurance. Universal life insurance is based on the premise of buy term and invest the difference.

By 2010 with the popularity of universal life insurance, fewer insurance companies offered whole life insurance policies. What has occurred is that all the investment risk was now the policy owner’s responsibility and the insurance agent became the financial advisor. Universal life insurance policies like any financial product can provide benefits to the policy owner or can be misused.

The biggest advantage of universal life insurance policies over whole life insurance policies is the lower cost of insurance. Universal life insurance policies have two components, the pure cost of insurance and investment options. In a universal life insurance policy the investments grow tax-deferred and are paid out together with the face value of the policy as a death benefit. Universal life insurance policies offer many advantages and flexibility not available with other types of permanent life insurance.

Insurance options for Universal Life Insurance

1. YRT (Yearly Renewable Term) – As the name implies it is a policy with rising premiums annually based on the age of the insured. During later years the premiums become very expensive, if the policy owner can no longer afford to pay the premiums the policy will lapse. This type of policy is based on the premise that the investment returns in the early years of the policy will be high enough to offset the higher premiums in the later years of the policy. This is an aggressive strategy that works if the investments perform or in a high interest rate environment. The preferred investment option chosen inside the universal life insurance policy is a stock market index or mutual fund.

2. Level Cost of Insurance – The premiums remain the same for the term of the policy. You are not required to invest in a universal life insurance policy it can be used as pure insurance. The level cost of insurance option is attractive. The premium for a level cost of insurance universal life insurance policy can be lower than a term to 100 life insurance policy. A level cost of insurance universal life insurance policy can also be overfunded. The investments grow tax-deferred inside the policy and are paid out together with the face value of the policy as a death benefit.

3. Single Premium, 10 Pay, 15 Pay and 20 Pay – This option is not offered by all insurance companies. As the name implies once you pay the premium payments for a period of 10, 15 or 20 years no additional premium payments are required. This option is attractive for policy owners that do not want to make insurance premium payments after they retire. The insurance company guarantees the face value of the policy and the number of premium payments to be paid. After all the required premium payments are paid the universal life insurance policy is paid off and no additional payments are required. The policy can also be overfunded. The investments grow tax-deferred and are paid out together with the face value of the policy as a death benefit.
   

Investment Options for Univeral Life Insurance

1. Daily Interest Savings Accounts,
   

2. (GIA) Guaranteed Interest Annuity (same as GIC’s sold by Banks and Trust Companies),
   

3. Stock Market Indexes (two types one that included dividend and one that does not) if the index does not include dividend the returns are substantially lower than the actual index.

4. Mutual funds offered as an investment option in universal life insurance policies. Mutual funds offered are Canadian equities, global equities and fixed income. Mutual funds investments can be conservative or aggressive.

5. Minimum Policy Guaranteed Returns – Universal life insurance policies with minimum guaranteed returns in their contracts of 3% or 4%. In today’s low interest rate environment minimum guarantees are very attractive. These attractive guarantees are no longer being offered due to the low interest rate environment. The most common guarantees offered inside universal life insurance policies is Bank Of Canada Rate, T Bill Rate or similar wording less 1.75%.

Overfunding Universal Life Insurance Policies

1. Take advantage of tax-deferred growth – investments grow on a tax-deferred basis up to the limit prescribed by the Income Tax Act of Canada. This is an attractive option for non-registered investments in GIC's, GIA's, segregated funds, mutual funds and index funds that would otherwise not benefit from tax-deferred growth. 

2. Use the money for retirement to supplement RRSPs, RRIFs and pensions. This is a concept that needs professional guidance. The policy can be borrowed against and used as collateral for a loan.  

Advantages and Disadvantages

of Overfunding a Universal Life Insurance Policy

1. If the universal life insurance policy is used as collateral for a policy loan to access funds in the policy, the lender can call the loan if the borrowing ratio is below their lending requirement. If one is forced to surrender the policy to pay off the loan it would have significant tax implications.

2. If investments in a universal life insurance policy are stock market indexes or mutual funds capital losses are disallowed.

3. If you need to withdraw money from a universal life insurance policy it may be taxed.

4. Investments inside a universal life insurance policy may be subject to surrender fees and in some universal life insurance policies the money can’t be accessed for a long period of time. If you decide to cancel the policy and cannot get your money out the amount you overfunded is used to pay for life insurance premiums. If there is no more money in the unversal life insurance policy and the premium is not paid, the policy will lapse. 

5. In order to take advantage of tax-deferred growth by over funding a universal life insurance policy the deposits are best made in the early years. The amount overfunded cannot exceed the MTAR (Maximum Taxable Actuarial Reserve). Deposits that exceed the MTAR (Maximum Taxable Actuarial Reserve) are put into a shuttle account and rolled into the universal life insurance policy gradually.

6. Premiums are also subject to premium tax, this is a provincial tax and Ontario does impose it.

7. An attractive investment option for conservative investors in universal life insurance policies is to collect interest. The money is investing in a guaranteed interest account, guaranteed interest annuity or a conservative fixed income fund. Interest earned on fixed income investments is fully taxed if invested in a non-registered account personally. In a universal life insurance policy interest earned on fixed income investments grows tax-deferred.

8. There are many other moving parts in a universal life insurance policy. The universal life insurance policy can include a term life insurance rider or a critical illness insurance rider. The benefit is if the investments inside the unversal life insurance policy perform the returns can be used to pay the premiums for the policy and the policy riders. This would result in tax savings versus having to pay the premiums for an individual term life insurance or critical illness insurance policy with after tax dollars.

Universal Life Insurance Illustrations

When you purchase or if you already own a universal life insurance policy you will or have already received an illustration. The illustration is an assumption of future returns, it is not a contract and the returns illustrated are not guaranteed.

During our years of servicing clients we have found that the policy owner assumes that the illustration is the actual return they will be receiving in their universal life insurance policy. The only guarantee is what is in the actual policy wording not the illustration. If you select an investment that accumulates interest than the rate of return is based on the interest rate paid by the insurance company at time of the deposit. Interest rates paid by insurance companies fluctuate just like GIC rates. If you select an investment in equity indexes or mutual funds there is no guaranteed return. Just like any investment the higher the risk the greater the potential return or loss and past performance is not indicative of future performance. The illustration is part of the policy that is based on projections of future returns.     

If the flexibility of a universal life insurance policy appeals to you contact us for a quote. If you already own a universal life insurance policy and would like to review it or get a second opinion we will be happy to assist you.

Contact Us for a Universal Life Insurance Quote

The information provided on this web site is intended for general information only. It should not be construed as legal, accounting, tax or specific insurance and investment advice. Clients should consult a professional advisor concerning their situations and any specific insurance and investment matters. While reasonable steps have been taken to ensure that this information was accurate as of the date hereof, Stone-Hedge Financial Group Inc. and its affiliates make no representation or warranty as to the accuracy of this information and assume no responsibility for reliance upon it.