Universal Life Insurance
Understanding universal life insurance and the key factors needed to make an informed decision before making any life insurance purchase.
If you’re looking to buy insurance, it’s easy to get caught in a dilemma of asking yourself which insurance is best. If you’re seeking coverage for the rest of your life and tax-free accumulation of cash value within a policy, then permanent life insurance may be an ideal option for you. But choosing the right permanent life insurance can be challenging, depending on your individual protection needs like tax-free benefits to cover final expenses, debt and legacy inheritances. One popular type of permanent life insurance is universal life insurance.
Universal Life Insurance vs. Term Life Insurance
There are two types of life insurance: term and permanent. How you choose between them depends on your goals, how long you'll need the insurance and how much you want to spend.
Universal life insurance is a type of permanent insurance (whole life insurance is another type). Permanent life insurance covers your entire lifetime and can be used for several goals, offering greater flexibility, but it is often initially more expensive than term insurance. You may be able to use permanent insurance to ensure you leave a specific amount of money to heirs or a charity, regardless of how long you live. Many permanent insurance policies also allow you to build cash value within the policy.
Term life insurance is generally used to cover a specific time frame versus a lifetime need. It also typically has the lowest initial cost, making it a great choice if you still have responsibilities of children at home and paying a mortgage. When the initial term period is up, you may be able to continue the policy, but premiums will be higher.
Here's a table to help you identify key differences between universal life insurance (a type of permanent insurance) and term life insurance.
| Universal Life Insurance | Term Life Insurance | |
|---|---|---|
| Premiums | Are initially higher in most cases than term insurance but has greater flexibility. This insurance typically lets you select your preferred premium schedule, the amount you want to pay (within limits) and an investment mix that matches your unique risk profile. | A lower-cost insurance product where clients have a choice of term lengths between 5 years and 50 years. |
| Death Benefit | Pays tax-free death benefits. For business owners, it allows for tax-efficient succession of the family business. Provides cash for equalizing distribution of assets for family members not in the business. Ability to accumulate cash values through dividends to purchase additional coverage. | Pays tax-free death benefits. Affordable coverage for temporary needs in the event of an untimely death (i.e., mortgage on second property) For business owners, it allows for tax-efficient succession of the family business. Provides cash for equalizing distribution of assets for family members not in the business. |
| Cash value | The cash value of permanent universal life insurance grows tax deferred. | No cash value |
| Benefits | Build wealth inside your policy, within limits, that you can access during your lifetime. | Can be converted to any permanent plan available at the time of conversion without evidence of insurability/underwriting up to the existing term policy amount. |
What is universal life insurance and why should you consider it?
Universal life insurance is a type of permanent life insurance policy that gives you coverage for your entire life, as long as it's adequately funded, offering flexible premiums and death benefits. Universal life insurance policies can be issued either on a single-life basis or joint-life basis with the death benefit paid at the first death or last death.
Universal life insurance provides a lump-sum tax-free benefit to beneficiaries on the death of the life insured(s). It is best suited for individuals seeking permanent life insurance protection where they might want to also take advantage of the opportunity to accumulate tax-advantaged policy cash values to help beneficiaries cover costs associated with final expenses, taxes on registered assets and capital gains.
Some of the advantages of universal life insurance include:
- Tax-deferred growth – The cash value of permanent universal life insurance grows tax deferred.
- Premium choice – Guaranteed level premium or increasing premiums each year, limited term or premiums being paid each year for life.
- Choice of investment option – You choose the investment mix that suits your needs based on guaranteed interest options, managed money and equity-linked investments.
- Cost – Option of locking a guaranteed level premium into the plan.
- Flexibility on death benefit.
What are the differences between universal and whole life insurance?
Universal life insurance differs from whole life insurance, which is another type of permanent life insurance that also offers guaranteed death benefits if your premiums are paid as scheduled. Whole life policy premiums tend to be higher compared to that of universal life. In addition, whole life insurance policies generally provide guaranteed and non-guaranteed cash values which grow every year. Growth is based on the performance of a large pool of assets managed by the insurance company’s team of asset managers. As a result of the product design, cash value in a whole life policy cannot go down as a result of investment performance.
Universal life insurance, on the other hand, offers flexibility to the policy owner in selecting interest and/or investment accounts. In that case, the cash value, death benefit, and amount of premiums required are affected by the performance of the selected accounts, and cash value can go up and down depending on how the investments selected perform.
| Whole Life Insurance | Universal Life Insurance | |
|---|---|---|
| Death Benefit | Provides guaranteed death benefit if premiums are paid as per the schedule. Policies can be issued on a single-life basis or a joint-life basis with the death benefit paid at the first death or the last death. | Offers a flexible death benefit, which might be the right option if you have less time for wealth accumulation and are focused on maximizing the policy’s death benefit for estate planning purposes. Policies can be issued on a single-life basis or a joint-life basis with the death benefit paid at the first death or the last death. |
| Premiums | Premium is specified when the policy is issued. | Includes flexible premiums, so you can choose how much premium you want to contribute, as long as it is above the minimum required to keep your policy in force and below the maximum set by CRA to keep your policy tax exempt. |
| Cash Value | Generally, this policy provides guaranteed and non-guaranteed cash values which grow every year. Growth is based on the performance of a large pool of assets managed by the insurance company’s team of asset managers. | Offers the ability for the policy owner to select interest and/or investment accounts. The cash value, death benefit and amount of premiums required are affected by the performance of the selected accounts. |
What is cash value?
Permanent life insurance policies (as opposed to term insurance policies) have a cash value. Premiums for permanent insurance policies go towards three things: cost of insurance, policy fees and charges, and cash value. The cash value of a permanent life insurance policy accumulates over time and can add to the total death benefit for the beneficiaries depending on the type of policy. While whole life policies always provide a guaranteed cash value, many also offer a non-guaranteed cash value as well. Non-guaranteed cash values are dependent on several factors the most significant being the actual performance of the pool of assets associated with these products often referred to as the Participating Fund (or Par Fund).
The growth of the cash value in a universal life insurance policy is tied to sub-accounts that contain investments chosen by the policy owner such as mutual funds and daily interest accounts.
Policy owners have several options if they want to access cash value within their policy, which can be done with a loan, withdrawal, or surrender (this applies to both whole and universal life insurance).
In case of withdrawal from a universal life insurance policy, the owner must have cash value available in the account. Part of every dollar withdrawn is taxable, unless the adjusted cost basis is higher than the cash value. The taxable portion depends on the proportionate amount of the adjusted cost basis.
Universal life insurance policies offer more flexibility than whole life insurance policies in terms of flexible death benefits, premiums and investment choices. Universal life insurance is comprised of two parts: cost of insurance and a saving component or cash value.
Cost of insurance is the minimum premium to be paid to keep the policy active. Cost of insurance varies from policy to policy depending on the policy owner’s age, insurability and the risk amount insured. This cost of insurance increases as the policy owner ages.
In universal life insurance plans, policy owners decide how funds in the savings component are invested. Multiple options are available depending on the insurance company ranging from savings accounts to market based portfolios.
Whether or not a medical exam will be required will depend on your age, health status and the amount of insurance you are applying for. Insurance companies examine the policy owner’s application and use “full medical underwriting” to rule out any medical history that could be detrimental to the company in the future. The insurance agent will verify the policy owner’s information and may also require applicants to take a life insurance medical exam.
The medical exam consists of checking height, weight, blood pressure, urine and potentially blood samples in order to rule out any medical history that could negatively impact the insurance company.
This type of test is generally completed by a paramedical professional hired by the insurance company and may be performed in your home. The result of the medical test can be used in determining the pricing policies, individual health and life application as well as motor vehicle record. The insurance company may even cross-reference the policy owner’s medical records.
If you plan to make a partial withdrawal from a universal life insurance policy at any time, the cash value as well as the death benefit may be will be impacted. Some policies have a minimum withdrawal of $500 and a maximum withdrawal dependent on the type of policy. The policy owner will have to pay income tax on any withdrawals from the policy, unless the adjusted cost basis is higher than the cash value.
There is also the opportunity to use cash value as collateral. For universal life policies, financial institutions that lend against insurance cash values will generally lend up to 50 percent of the cash value for leveraging purposes. The policy owner has the flexibility to repay the loan at any time. Cash value continues to grow if the invested money is untouched.
Upon cancellation of the universal life insurance policy, the cash surrender value is received by the policy owner. During the early years of a policy there may be a penalty for cancelling called a surrender charge. Some policies have no surrender charge. The policy owner may have to pay income tax on the amount received in the year the policy is cancelled.
The amount of insurance coverage one needs is depenent on a number of factors. Often times permanent insurance, such as universal life, is purchased to protect the value of your estate for loved ones by providing liquid capital to pay tax liabilities on assets that have grown significantly in value, like a recreational property or a business. Universal Life insurance can also be used for estate equalization purposes, or to meet charitable intentions. When considering a universal life insurance policy, keep in mind your household income, net worth, income replacement needs, estate liquidity needs (taxes and final expenses), and outstanding debt before choosing an insurance policy. Try our free, easy-to-use insurance calculator here.
There are several variables that determine the cost of your policy. Here are a few of the main factors:
- Age: Since universal life insurance covers you for a lifetime, the premium amount increases as the policy owner ages. For instance, if you choose to be covered until 75 years of age, the premium would be less than if you chose to be covered until age 90.
- Health: The policy premium will depend on the owner’s medical family history; chronic diseases and lifestyle can potentially increase costs. A medical underwriting exam is also required by some insurance companies before approving the policy.
- Gender: On average, women typically live longer than men, so insurance may be less expensive for women.
- High Risk Behaviours: The insurance policy premium may be higher if the policy owner has a dangerous or life-threatening job or high risk hobbies such as sky diving.
We can help
At Edward Jones, we can find you the right financial advisor to help you move one step closer to your financial goals. We’ll help you navigate your life insurance policy options to make an informed decision possible. Reach out to an Edward Jones financial advisor to find the option that is right for you.
Important information:
Insurance and annuities are offered by Edward Jones Insurance Agency (except in Québec). In Québec, insurance and annuities are offered by Edward Jones Insurance Agency (Québec) Inc.