What is universal life insurance?
Universal life insurance is a form of permanent life insurance, meaning it offers lifelong coverage as long as you keep making the 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 all 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 in your insurance investment account 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 withdraw money or borrow against the cash value of your policy with an interest-bearing loan. The cash value refers to the 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.
Who is universal life insurance for?
Universal life insurance is designed for a very specific type of individual, and it doesn’t make sense for everyone, says Steve Bridge, an advice-only certified financial planner with Money Coaches Canada. First, you’ll have a need for permanent life insurance, which provides coverage until you die, he says. “If you don’t have a need [for this type of coverage], then universal life insurance is not for you. The vast majority of people do not need permanent life insurance—term insurance is usually sufficient.”
Term life can provide sufficient coverage to someone who wants to protect their family’s financial health until the kids are out of the house and the mortgage is paid off—and it’s usually cheaper and simpler than universal life, says Bridge. On the other hand, “If you maxed out your RRSPs, TFSAs and RESPs and have a need for permanent coverage, then you could consider universal life.” (Read more about registered retirement savings plans, tax-free savings accounts and registered education savings plans.)
What are the benefits of universal life insurance?
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 isn’t a good fit for everyone. However, there are benefits for those prepared to spend the time to understand the nuances of universal life insurance:
- Control over your policy: Unlike with other life insurance policies, the policy holder can decide how to invest the money in their account.
- Flexible premiums: The premiums are also more flexible. You can pay more and invest the balance, or you can choose to pay less or even skip payments entirely, as long as you already have enough in the account to cover the premiums.
- Withdrawals: You can borrow or withdraw funds from your policy account; however, each policy may have different requirements for withdrawals and loans.
- Changes in the policy’s cash value: If your investments do well, you could end up with a larger cash value. Of course, the flip side is also true: You can also lose money, if your investments perform poorly.
What are the disadvantages of universal life insurance?
Like any financial product, universal life insurance does have its disadvantages. In fact, Bridge believes that “universal life insurance is really not suitable for most people. Term is better for most.” Here’s a look at some of the downsides of universal life insurance for Canadians:
