Matt Hands, VP, Insurance and MoneySense
Universal life insurance is a type of permanent life insurance product which combines a death benefit with an investment component. Like other types of life insurance, these plans pay out a set lump sum to your named beneficiaries upon your passing, offering coverage for various needs, such as estate planning. A portion of your premiums also go towards a cash value reserve – this is an investment account which allows your money to grow on a tax-deferred basis.
Although complex, a universal life insurance policy is still a form of life insurance coverage at its core. This means that by paying regular premiums, your insurance provider agrees to pay out a set death benefit to your loved ones upon your passing.
There are two components to your premium payments. Firstly, you'll need to cover the cost of insurance – this is the minimum amount you need to pay in order to keep your policy active, covering administrative fees. Anything paid on top of this goes towards your cash value account which is a reserve of funds you can access during your lifetime.
The cash value is used for investing as money within this account grows on a tax-deferred basis – you won't need to pay income tax on the gains until you take out earnings. In comparison to whole life insurance, the cash value account for a universal plan comes with more options. You can choose where you want your funds invested (e.g. stocks, bonds), depending on the level of risk you're comfortable with taking on. Some policies offer minimal guaranteed interest rates while others allow you to invest in index and variable funds.
As your cash value grows, you can withdraw or borrow from it. Withdrawals often come with tax implications, but if you're planning on paying the money back, you'll usually only be subject to interest. If there are enough funds, you can also use the cash reserve to cover the base cost of insurance, allowing you to lower your out-of-pocket premium payments.
Aside from the flexibility of your premiums, the death benefit on a universal life insurance policy is also flexible. If you find that you need more or less coverage, you can negotiate with your insurer – increasing the amount, however, may require a medical exam.
Because these policies are a form of permanent life insurance, the benefit will eventually be paid out after death. Your loved ones will receive a tax-free lump sum that can be used for anything – estate planning, succession planning, and more. Any unused cash value, however, is generally left with the life insurance company.
Universal life insurance can be a worthwhile product, but it's not for everyone. If you only need coverage temporarily – say to cover an outstanding mortgage – then term life insurance will most likely be the more suitable, cost-effective option. And even if you've determined the need for a permanent policy, whole life insurance can offer more simplicity and less risk.
Universal life plans are designed to meet the needs of specific individuals – those looking for flexible policy options and tax-advantaged investing (especially after other accounts, such as the TFSA and RRSP, are maxed out). Here are a few sample scenarios in which this type of policy could come in handy.
Because of the tax advantages, universal life insurance is best-suited for high-income earners who have already maxed out other investment options (e.g. TFSA, RRSP).
The cash value earnings are based on your own investment choices, so having the financial knowledge can help. You may also choose to work with a financial advisor.
Universal life plans can be used for various business needs – acting as key person insurance, funding a buy-sell agreement, or providing funds for a succession plan.
Universal life insurance can help with estate planning and wealth transfer needs. For instance, the death benefit can cover estate taxes owed upon death.
You can also name a charity as a beneficiary, giving back in a tax-advantaged way (while reaping lifetime benefits with the cash value).
Because you can withdraw or borrow from it, the cash value account can be used to supplement your retirement fund in a tax-efficient manner.
Lifetime coverage – Unlike term life insurance, your death benefit does not expire, guaranteeing a payout to your beneficiaries upon your passing (provided all your policy terms are met).
Flexible premiums – Your premium payments can fluctuate, up to certain policy limits. Having enough funds in your cash value reserve can also allow you to skip payments or make smaller contributions if needed.
Flexible death benefit – Coverage needs can change during your lifetime, making universal life insurance an appealing option. You can potentially negotiate a lower benefit (allowing you to pay smaller premiums) or a higher benefit for added protection. Increasing it, however, may require you to complete a medical exam.
Cash value reserve – Like whole life insurance, universal plans come with a cash value reserve. This is money that you can access during your lifetime through withdrawals or loans, allowing you to receive peace of mind with an emergency fund in place.
Tax-advantages – The investments in your cash value reserve grow on a tax-deferred basis, meaning you'll only need to pay taxes when you withdraw more than the amount you've put in – and you can choose to do this when it best suits your situation. Plus, like other life insurance products, the death benefit is paid out to your beneficiaries upon your passing without tax implications.
Policy complexity – It can be difficult to reap the full benefits of a universal life insurance policy because of its complex structure. Policyholders of these plans often have prior investment knowledge or choose to work with a financial advisor.
Risk of underfunding – With a universal life insurance, you'll need to monitor your policy carefully. If your cash value investments fall and your premiums don't cover the base cost of insurance, your policy can lapse, leaving you without any coverage.
Risk of underperforming – The ability to choose your own investments can also mean underperformance, implicating your case value reserve. If your earnings aren't high enough, you may also need to increase your premium payments to cover the base cost of insurance.
Cash value loss after death – Like whole life insurance, any unused funds in your cash value reserve typically won't be paid out to your beneficiaries. Instead, it'll be surrendered to the insurance company.
Expensive cost – Universal life insurance can be cheaper than whole life insurance, but because it offers lifelong coverage, it's still generally much more expensive than term life insurance.
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While the cost of universal life insurance will differ on a case-to-case basis, here are three average rates we pulled from top Canadian providers. Keep in mind, however, that these numbers are representative of one hypothetical policyholder – to find the exact cost you'll be paying, be sure to compare universal life insurance quotes with us today.
Universal life policy with $150,000 coverage
minimum payment for a 42-year-old, non-smoking female
Universal life policy with $500,000 coverage
minimum payment for a 38-year-old, non-smoking male
Universal life policy with $300,000 coverage
minimum payment for a 55-year-old, non-smoking male
While the premiums you pay for a universal life insurance policy are flexible, you'll still need to make sure your cost of life insurance is covered – this is the minimum amount of money needed to ensure your policy stays active. Insurers offer quotes for minimum payments based on several different factors, including the following.
The older you are, the more expensive life insurance gets. While some universal life plans have a cost of insurance that's fixed, others may increase overtime.
Men typically pay higher rates when it comes to life insurance. Statistically speaking, males have a shorter life expectancy than females.
If you have a pre-existing condition, universal life insurance can get much more costly. This may also be the case if your family has a history of medical issues.
Smokers are subject to higher universal life insurance rates due to the added health risks. And working a high-risk job (e.g. firefighter) can also impact your rate.
The death benefit on a universal life insurance plan is flexible, and choosing a higher one will inevitably lead to a higher cost.
The type of investment plan you choose may impact your life insurance rate. Plus, adding on policy riders will only bring the payments up.
Universal life insurance and whole life insurance are two of the most popular types of permanent plans – here, we cover the main policy features of the products, so you can better understand the similarities and differences.
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Are universal life insurance policies a good investment?
Universal life insurance can be a good investment, but these plans aren't right for everyone. For instance, if you only need temporary coverage, term life insurance may be the better option as it's more cost-effective. And if you do need permanent coverage, whole life insurance can offer a more simple, guaranteed solution.
If you're unsure which type of coverage is most suitable for your needs, be sure to speak to a licensed life insurance broker in Canada for guidance.
Does universal life insurance expire?
No, universal life insurance is a permanent life insurance product, meaning you'll be covered for an entire lifetime (unlike term life insurance). However, if your investments perform poorly – causing your cash value to decrease – and your premium payments aren't enough to make up for it, the policy can lapse.
Are universal life insurance premiums tax-deductible?
In most cases, the premiums paid out for a universal life insurance policy are not tax-deductible. One exception, however, is if the policy is used for business purposes (e.g. acting as key person coverage, funding a buy-sell agreement) – in this scenario, the premiums could potentially be deducted from the business's taxable income.
On the other hand, the cash value put into a universal life policy grows on a tax-deferred basis. This means you won't need to pay income tax on the earnings until you access it through a withdrawal. Plus, policy loans typically aren't taxed – although you may need to pay interest on the amount.
For more information on leveraging the tax advantages of a universal life insurance policy, be sure to consult a professional in Canada.
Can I withdraw money from my universal life insurance policy?
Yes, universal life insurance policies come with a cash reserve which can be accessed during your lifetime. While withdrawing from it can come with tax implications, it can be a good option for various reasons – such as emergency coverage for critical illness or supplemental funds for retirement.
Can you borrow against a universal life insurance policy?
Yes, borrowing from your policy's cash value is one way to access its funds during your lifetime. Although you typically won't need to pay taxes on the amount, keep in mind that you could be subject to paying interest. Unpaid loans can also decrease your policy's death benefit, so be sure you understand all the implications before taking money out.