Universal Life Insurance Explained

Whole Life vs. Universal Life

Both universal and whole life policies are permanent life insurance. This means that they both offer lifetime coverage to their policyholders. However, part of the reason why a universal life policy was formulated was to deal with certain shortcomings in a whole life insurance policy. When one takes out a whole life policy, they are guaranteed level premiums and cash values. They can also choose between a non-participating or a participating whole life policy.

A non-participating policy costs less, but lacks dividend payouts. A participating policy, on the other hand, allows the insured to be part of the carrier’s profits and also offers dividend payouts. However, the main shortcoming of whole life policy is that it does not disclose how premiums are distributed among costs of administration, insurance costs, and the investment fraction. Also, it does not have the flexibility in investment options that is characteristic of universal life insurance.

How a Universal Life Policy Works

When you buy a universal life policy, your money will immediately be placed into a holding account. Your insurer will then invest your money in one or more investment vehicles of your choice. This could be segregated funds, mutual funds, term deposits and daily interest accounts.Since you get to choose the investment vehicles, it frees the insurance company of any risk pertaining to your choices. Your invested money will then grow tax-free, from which your insurer will fund your life insurance and pay for administrative costs. A universal policy will therefore work best for someone with the following profile:

  • A need for a life insurance policy.
  • High-marginal tax category.
  • A need for extra future income.
  • A maximized pension and RRSP contribution.
  • A minimum of ten years investment horizon.
  • Someone whose investment income is highly taxed.

Advantages of a Universal Life Policy

  1. Savings: A universal life policy provides a tax-sheltered savings account, which earns a set rate of interest that is monthly credited to a policyholder’s account, rather than yearly.
  2. Flexibility: Unlike whole life insurance, which is rigid in its policy, a universal life insurance offers great flexibility. The coverage amount is entirely up to you, and you can adjust it at any time depending on your needs.
  3. Withdrawals/Loans: You can withdraw money or take a loan against your universal life cash value account. If you pass away and you still have unpaid loans from your account, the loan amount will be deducted from the death benefit. Details of how much or how frequently to withdraw or take a loan are unique to each insurance company.
  4. Charges: If you surrender or withdraw money from your universal insurance cash value, you may be charged for it. Note that by surrendering the cash value, any unpaid loan or charges will be deducted from the total amount of money in your account, and the remainder will be given to you.
  5. Options: A universal life insurance policy offers many options. Apart from being provided with a guaranteed life insurance, you can also include your family and other dependants as your term life riders. Also, if you become disabled, you can waive your policy’s monthly premiums.
  6. Death benefits: A universal life policy provides a tax-sheltered death benefit. As a policyholder, you also get to choose whether you want your beneficiary to receive the cash value, the life insurance payout, or both.