What is Universal Life Insurance?

August 12th, 2011 | Author: Mitch Reynolds

What is Universal Life Insurance and How Does It Work

This article, what is universal life insurance is the fourth in a series of articles explaining the fundamentals of how different insurance products work. To get a full list of all articles in this series, please go to What is Insurance for the series overview.

Definition of What is Universal Life Insurance

What is Universal Life Insurance? Universal Life or UL is a type of permanent life insurance in Canada. Universal life insurance is offered by most Canadian insurance companies. The basis of the plan is that a premium payment (monthly or annual cost of the life insurance) is established at some point higher than the minimum cost of insurance (COI). The excess funds deposited into the investment account of the universal life insurance plan earn interest. The potential earnings of the investment account can be pegged to the performance of stocks, bonds or guaranteed interest accounts, like a GIC.

It is often referred to as a broken policy where the cost of insurance (COI) is separate from the investments and interest earned by the policy. This means that the investment account is not connected to the life insurance amount. This gives the policy owner flexibility in what they wish to pay and how much they want to invest into the plan.

The cost of the death benefit inside a universal life insurance plan can be structured as either level for life or yearly renewable term insurance. The level for life cost of insurance is built on a Term 100 structure, which has a basic price for the death benefit which will remain constant for the rest of the insured’s life. A yearly renewable term (YRT) cost of insurance structure has a much lower cost to insure the death benefit in the early years of the policy, while the insured is younger. As they age, the cost to insure the death benefit increases each year and becomes very expensive as a person ages. The COI of a level plan starts higher than a YRT cost but will be significantly less expensive as the insured ages. If a person is investing heavily into a YRT poloicy, the excess money put into the investment account in the early years will compound faster than in a more expensive Level plan. The hope is that the larger investment account, compounding faster, will offset the increased cost of insurance in the later years if the insured lives a long time.

Also see Limited Pay Universal Life Insurance.

How does universal life insurance work?

As started above, all premiums invested into a universal life insurance policy are placed into the investment account (creating the policies cash value). Each month the insurance company withdraws the cost of insurance and any other fees attached to the policy. The remaining money is pegged to some kind of investment product.

An insured who owns a universal life insurance policy can chose equity based investment funds, bond funds, guaranteed investment products similar to a GIC or even a daily interest account. Many Canadian insurance companies offer special accounts within their universal life insurance product which have interest bonuses based on things like policy age, excess investment above the COI, and protection from market losses like a GMWB.

Death benefit structure: The death benefit of a universal life insurance plan can be either “face+fund” or just “face amount”. A face plus fund plan has a life time cost of insurance for the original amount of death benefit purchased. The excess funds in the investment account create additional life insurance, as upon death the value of the investment account is added to the original death benefit, and both are paid out to the beneficiaries of the policy. A face amount policy has a reducing premium, as the excess funds growing inside the investment account reduce the amount of life insurance the client is paying for, therefore their COI reduces as the cash value increases. Once the cash value of the investment account exceeds the original death benefit purchased, there is no more cost of insurance and the policy becomes a pure tax deferred/sheltered investment plan.

The tax status of universal life insurance

One of the things that makes universal life insurance an attractive investment and risk protection tool in Canada is the tax treatment of the plan by the Canada Revenue Agency (CRA). All excess funds placed into the investment account of a universal life insurance plan that are growing with interest earnings are fully tax sheltered from capital gains tax or interest tax so long as the funds remain within the universal life investment account. If funds are withdrawn, any growth above the adjusted cost base of the funds in the investment account will be subject to interest earnings tax, which is the same as personal income tax.

If the funds remain in the investment account until the death of the insured, the entire investment account could be added to the original amount death benefit purchased (in a face plus fund plan), and paid out tax free, since all tax free, as all death benefits in Canada are non-taxable for exempt life insurance policies.

Universal life insurance which is overfunded and building up a sizable cash value can be used as collateral on a loan. The tax sheltered status of the investment account, conversion to a tax free death benefit and the ability to loan tax free cash flow off the policy has lead to some very powerful retirement and investment leveraging strategies in Canada.

What is Universal Life Insurance – find out more from Life Guard Insurance.

At Life Guard Insurance, we know universal life insurance can be very complicated. You need a qualified advisor to help you through the product to really understand what is universal life insurance, and if it is right for you. Feel free to contact us at Life Guard Insurance to find out what is universal life insurance and how it might fit your financial plan.

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