As a society, financial independence is what we’re all striving for, particularly in this unstable economy. The best way to achieve it is to take things into your own hands; and make thoughtful investment decisions.
Insurance can be an investment vehicle where you can have the best of both worlds. It’s a way to build financial independence and leave money to your heirs, provided you get insurance with an investment component.
Universal life insurance is a type of insurance that builds wealth. To see if this type of life insurance is something you should look into, below we will look at the basics to understanding universal life insurance (UL).
What is Universal Life Insurance?
Just like whole life insurance, it offers low-cost protection and has a savings element to help build-up cash value. The main difference is that with UL insurance, the policyholder can use the interest from the policies’ accumulated savings to help pay for the insurance premiums.
The Flexibility of Universal Life Insurance
One of the best things about UL insurance is its flexibility, because it allows you to:
- Alter your monthly deposit;
- Choose an increasing death benefit or a level benefit; and,
- Adjust investment choices within a tax-sheltered account.
Variables to Consider Before Buying Universal Life Insurance
Because of UL’S flexibility there are variables to consider before buying this policy. Below we will look at tips to understand them better:
- Level Cost Insurance (COI) vs. Increasing Cost of Insurance (COI): Level COI guarantees that the cost of policy stays the same for life; while increasing COI offers a lower initial cost that escalates annually. The advantage of this is that it can accumulate cash quicker in the early years; the disadvantage is that if the investment portion doesn’t perform well, you will have escalating premiums.
- Risk Profile Choices: As with all investments, you have to decide what your risk level is – play it safe, or go for a higher possible return. For example, you can choose a safer savings account such as a GIC. Since this is such a major component of investments, you need to know your personal risk level.
- Death Benefit Choices: You can choose an increasing benefit (the basic face amount and any cash accumulation), or a level death benefit (limited to the basic face amount). The benefit of choosing a level death benefit is that the risk charge can decrease as the cash value builds. You end up with a lower risk charge, and higher cash accumulation.
- Accessibility to Cash Value: A lot of UL policies have very high costs associated with terminating coverage in the policies early years.
- Research: Policies can dramatically change between companies, so it is best to go to an independent broker to get advice that is unbiased.
One of the biggest questions you probably have now, is “What are the tax benefits of Universal life insurance?” Below we talk about the top tax benefits for Canadians.
Top 5 Tax Benefit Advantages of Universal Life Insurance
- Tax Free Death Benefits: Whether you choose a level COI or increasing COI, the policy amounts paid to beneficiaries is tax free.
- Tax Shelter: Universal life insurance policies have a policy accumulation fund component; and it grows on a tax sheltered basis. The majority of Canadian insurance companies offer a range of investment options, for all risk levels.
- No Impact on contribution limits for RSP and Tax-Free Savings Accounts: UL insurance contributions stand alone from all other tax-free savings or retirement accounts.
- Pre-tax Dollars for Accumulation Fund Withdrawals: When you use your policy accumulation fund so you can offset premiums in the future, you do it with pre-tax dollars. So the money within the fund will continue to grow under the protection of a tax shelter.
- No Tax Ramification: If the accumulation fund stays within the policy and is used against future premiums, there are no tax ramifications.
As you can see, choosing life insurance with an investment component, while a great idea for select people, it can be complicated. It’s very important to make an informed decision and weigh the pros and cons of each type. Universal life is really beneficial to some, but it’s not for everyone. Consult with a knowledgeable broker to learn more.