Ahhh my poor misunderstood universal life. Universal Life (or UL) insurance was created in the early 80’s for wealthy Americans to have another mechanism to grow investments on a tax-free basis. The popularity of them grew quite substantially over the next 20 years as we had a very high interest rate environment. UL’s were used quite effectively to grow and shelter billions of dollars for wealthy individuals and has helped them fund retirements and transfer money to the next of kin tax free.
However, it has also destroyed a lot of family’s financial futures and caused havoc in the industry.
Let’s discuss how it works:
A UL policy has two main components;
The cost of Insurance (COI)
- Level Cost until death (LCOI) – Same cost until death
- Yearly Renewable Term (YRT) – Premium increases each year
The fund account (Investment account)
These two components were “unbundled” which means you could increase or decrease any amount as desired within certain limits. The idea between universal life is that you would deposit a premium that would include the cost of insurance as well as an amount to put into an investment account. The investment would grow tax free (within certain limits) and eventually you would be earning enough income off your investment to pay for the cost of the insurance.
In theory this works quite well, UL’s are cheaper than Whole Life insurance and much more flexible which has been a desirable trait. However, they are incredibly complicated contracts that most advisers don’t even understand let alone their clients.
Since the investment component is active it needs to be managed and monitored as not only can you earn returns in there, but you can also lose returns in there as well. There are no guarantees within a UL policy and the policy holder takes all the risk in it.
It needs to be managed and implemented by a competent adviser who understands how they work. Unfortunately, most insurance advisers exit the industry within 5 years and leave behind a trail of poorly constructed UL’s that clients have no idea how to manage.
This usually leads to them paying premiums for decades only to realize that at age 60 their policy will collapse, and they will lose everything they put in. This could be due to their investment choices or their cost of insurance choices.
As you can see there is simply too much information to contain this all in one post.
If you have a UL or would like more information on the mechanics of how they work please reach out.