This is part 3 in a 3 part article intended to make the types of life insurance less confusing.
These three articles should be read in order.
- Life Insurance Types – Term life insurance
- Life Insurance Types – Whole Life and Term To 100
- Life Insurance Types – Universal Life Insurance
(Continued from previous article)
The third and final type of permanent insurance is called Universal Life Insurance. Basically what the insurance companies have done is take a Term to 100 policy and added an investment vehicle on the side. The investment vehicle works kind of like an RRSP or a mutual fund, though it is neither.
The investment portion is flexible – you don’t have to put in money, or you can at different intervals (subject to some government guidelines). Let’s say for example the Term to 100 premium inside a universal life policy is $100 a month. If you pay $100 a month, the insurance takes the premium and pays your Term to 100 premium – end of story. So what you basically have is a term to 100 policy.
Now if instead you pay $200 a month into the universal life insurance policy the company takes the first $100 and pays your Term to 100 life insurance premiums dapoxetine priligy. They then take the remaining $100 and put it into the investment portion of your policy. Unlike an RRSP, those contributions are not tax deductible. However like an RRSP, the investment inside a Universal Life insurance policy grows on a tax sheltered basis.
That tax sheltering of the earnings on the investment portion have led to all sorts of weird and wonderful sales concepts from the life insurance industry. If tax sheltering isn’t an issue, UL probably isn’t for you. However for higher income and more affluent individuals, this tax sheltering can be very beneficial.
Here’s two simplified examples. Let’s say your premiums on the Term to 100 policy are $10,000 a year. And let’s assume you have managed to put $100,000 into the investment portion of the Universal Life policy. Let’s make a big jump and assume your investment portion earns 10% :). So your $100,000 investment produces $10,000. Now here’s the cool part. If you use that $10,000 from the investment to pay your life insurance premiums, you’ve just paid your insurance premiums with pre-tax dollars! Doing the same thing outside a Universal Life Insurance policy means you’d probably have to earn $20,000, pay about $10,000 in taxes to leave you with the $10,000 needed to pay your premium.
Another example that is a bit more aggressive involves a bit of leveraging. Let’s say you build up a substantial amount inside your Universal Life Insurance policy over the years prior to retiring. Now you’ve got a ton of cash sitting there that you can’t pull out without paying taxes on (since the earnings inside the policy are only tax deferred until you pull the money out). So instead of pulling the money out of the policy, you use the policy as collateral on a loan from a bank. The loan of course is tax free money. The banks will have some limites on the amount of the loan with relation to the amount of money in the insurance policy, but it can be set up so that you never pay the bank back – they get their loan paid back when you die from the insurance policy (which pays out the life insurance amount plus the investment amount). Voila – getting at tax deferred income without paying the tax on it. No, I have no idea why CRA lets our industry get away with that one :).
Two other points on Universal Life Insurance. First, in addition to having Term to 100 as an insurance component, some companies also offer 1 year term insurance as the insurance component (see the 1 year term insurance explanation in my previous post on term insurance). The idea is that the cheaper premiums of 1 year term in the early years allows you to save more money earlier to invest faster for the later years (more money earlier allows that money to compound for a longer period). If you can make money inside the policy fast enough, you can have a bigger investment portion and have enough money to pay the very high term premiums later in life. Of course if your investments don’t grow fast enough you’re going to end up with a very very expensive life insurance policy later in life when it’s likely too late to do anything about it. Secondly, the investment portion of Universal Life is generally not guaranteed. The old adage ‘past results are not indicative of future returns’ applies in spades. Be careful when evaluating Universal Life insurance scenarios that depend on non-guaranteed portions of the contract.
One last note about Universal Life insurance. If you are looking at permanent insurance, Term to 100 is generally where I’d start shopping as we’d expect that to be the least expensive. For competitive reasons though, sometimes the Term to 100 insurance component inside a Universal Life policy may cost the same or less than buying the Term to 100 policy discretely. It’s worth pricing out a Universal Life policy when looking at Term to 100 just to get the cost differential. If it’s minimal – and in many cases it is – you should consider the Universal life policy. Even if you treat it as a Term to 100 policy and ignore the investment portion, you’re getting the ability to use that feature in the future for little cost.
In summary, the conceptual basis of all life insurance is 1 year term. Averaging out the premiums gives us products like 10 year term and 20 year term which work well for 10 or 20 year needs and is suitable for many people. For people with longer term insurance needs permanent insurance fits the bill. There are three types of permanent insurance; whole life which has fallen out of favour with consumer advocates, Term to 100 which is a stripped down version of whole life without cash values, and Universal Life insurance which is Term to 100 life insurance with an investment vehicle added to it.