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Pros and cons of universal life insurance.
by Robert Kavanagh
A universal life insurance plan typically consists of insurance coverage in the form of permanent or whole-life insurance combined with an investment component (also called the reserve account). In a universal life plan the policyholder can set the investment goals of the reserve account. The premiums are based on the desired balance between insurance and investment. A portion of the premiums cover administration and the death benefit; the remaining cash is essentially at the disposal of the policyholder.
Universal life insurance allows people to shelter investments from taxation. This can be extremely attractive for people who are maximizing their RRSPs and are interested in alternate ways to shelter more of their holdings from tax. For physicians who are incorporated, these life insurance policies can be held by the corporation which can be even more attractive.
Investment options for the reserve account include daily interest savings account, term deposit type account, and domestic and foreign equity market index accounts.
The investment component of universal life policies can be used as collateral for loans, since it belongs to the policyholder and not the insurance company. This form of leveraging can be used to fund retirement income while leaving the policy’s death benefit in place.
Advantages
- Investment component earnings are tax-deferred. However, to maintain tax-exempt status, the plan must maintain a certain level of investments in relation to the insurance component.
- Investment component can be used as collateral for loans or withdrawn from the plan.
- Paying more than the minimum premium can provide considerable tax savings through the tax deferral mechanism described above.
- Policyholders can vary the amount and timing of premium payments, and the amount of coverage.
Disadvantages
- Unlike RRSPs, deposits to a universal life policy in the form of premiums are not tax-deductible
- The cash value of the policy and the size of required contributions are not guaranteed, but are related to the performance of the investment account.
- If the anticipated rate of return is too optimistic, the policy may become under-funded.
Suitability Issues
Universal life policies are suitable for individuals with the following characteristics:
- Need or want insurance and are willing to assume some risk of the policy.
Want to build up equity in the insurance plan.
- Have maximized their RRSP contributions and wish to defer taxes on investment income.
Universal life insurance policies have a multitude of features. They have a wide range of investment and premium deposit flexibility. Because of the complexity in these policies it is crucial to discuss with your financial consultant whether you could benefit from these strategies.
Robert Kavanagh, MBA, CFP is a senior financial consultant with MD Management’s Newfoundland and Labrador regional office.
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