Universal Life [UL]- The Flexible Life Insurance
The following pages provide a detailed analysis of Universal Life plan generically highlighting its various components, elements and how it operates.
BASICS - UL vs other Life Insurance
Life insurance may be categorized into four major plan groups.
- Term Specific ( 1yr, 5yr, 10yr Term)
- Life Long Term ( Term to Age 100)
- Whole Life (Permanent plan with Cash Values with or without Dividends)
- Universal Life
Term Specific & Life Long Term are typically pure risk plans with no cash values or living benefits of any kind. (Some highbrids exist).
Whole Life provides cash values either on a guaranteed basis or on a performance basis or both. Participating Whole Life policies provide a minimum amount of guaranteed cash value plus a non guaranteed performance based cash value in the form of dividends. In whole life contracts the policy owner is a passive participant, and relies entirely on the competence of the insurer for these non guaranteed values which are dependent on such factors as mortality, expenses and investment performance.
Universal Life [UL]is an insurance product that packages the three separate but key elements of a whole life policy;
Insurance Protection Cost; Administration Expenses; & Investment.
Risk Cost: The annual charge for the cost of the insurance protection.
Admin. Cost: The annual cost of administering the policy contract including premium tax.
Investment: The deposits plan holder commits for the Protection & Admin. costs + the Savings in the contract.
Universal Life contracts offer the plan holder the opportunity to share in the risks of one or all of these three components.
Risk Cost: Some UL plans offer insurance risk costs that can change if the mortality assumed in the original price changes; up or down. The policy owner shares in this risk by allowing the change in the price of the risk charged. Others guarantee the risk charge cost never to change. The risk costs are charged to the policy monthly from the "investment bucket" of the policy.
Admin Cost: This charge is the annual charge to administer the policy. Some plans provide a corridor of current cost to a maximum annual charge. Some even have a maximum annual increase within this corridor. Some plans contractually fix the annual cost at the outset.
Investment: For the savings portion of deposits there are two types of investment choices in a universal life contract. One is inside the contract on a tax favoured basis, often called the exempt portion, while the other is outside the tax favoured umbrella referred to as the Non-Exempt portion.
Non-Exempt UL Investment
Investments outside the tax shelter umbrella can act very much like any other investment chosen with respect to the yield types they throw. The yield may be composed of the traditional interest, dividends or capital gains. These attract annual taxation at their respective rates. The only advantage they have over any comparable stand alone investment is the bonus investment credits the plan may generate for having it stay attached to the UL plus the creditor proof element. There may be redemption charges for early withdrawals from the plan.
Some plans allow you to attach your RRSP contribution to the plan. This then creates the same bonus (mentioned above) to the RRSP portion as well. Most UL investment Options that offer foreign investment exposures mirror foreign indexes thus allowing 100% RRSP eligibility for the RRSP portion attached to the UL plan. RRSP attached to ULs must be severed by age 69. No RRIFs are allowed to be attached.
Exempt UL Investment
Investments that stay inside the tax favoured portion of the UL have only one yield type, interest; thus while accumulating, the fund values are tax deferred but upon withdrawal, the funds attract taxation at the rate for interest income. If by withdrawal, the Adjusted Cost Base (ACB) of the plan = 0 then the withdrawal is 100% taxable at the owner's marginal tax rate.
Investment choices under a UL contract can be
- GIC -like investments emulating investment terms ranging from Daily Interest to 10 year terms.
- Bonds - They usually emulate returns of mid or long term Bond Funds;
- Stock Market Indexes, like
- TSE, S&P, Dax, FTSE, Nikkai, etc.
- Mutual Funds Emulations - like
- CI, Templeton, Trimark, Fidelity, Mackenzie etc.
The returns that are actually credited are a percentage of the index they are emulating. This fraction can be equated to the Management Expense Ratios of Mutual Funds of (MERs)
This credit can be as high as 100% of the underlying yield or some amount less than 100% In the stock market indexes it can be the "Total Index" which includes dividends reinvested or the "Index" exclusive of dividends. In the Bond arena a Yield credit may be expressed as 90% of a specific Bond Index less 2% on the up side and 110% plus 2% on the down side.
The crediting methodology can dramatically impact on the actual yield credited to the contract. Particular attention to this element is highly recommended.
Early Cash Surrender
The policy term of a UL contract refer to "Account Value" - the monies credited to the contract after the insurance and other expenses have been deducted. It also refers to "Cash Value" - the portion of the Account Value that is actually accessible at any given time. In the early policy years the Cash Values are less than the Account Values. At some point the become equal. Typically this occurs in the 11th contract year and onward. Universal Life plans are long term contracts and are not good value in the short term.
There is no HST in insurance premiums but each province has a set premium tax that they must deduct from each deposit and remit to the province. This premium varies by province. Averaging from 2 - 3%
A graphic illustration of the mechanics of the exempt portion of a UL are shown below.
Type 1: Multiple Lives
Type 2: Joint First to die
Type 3: Joint Last to die
This flexibility creates incredible planning opportunities to deal with specific financial contingencies at significant cost effectiveness.
Type 3: Is the best kept secret and the best buy for many Canadians.
Unlike our friends to the south of the border, Canadian universal life policies only have the one name, Universal Life regardless whether the investment choice is fixed or variable.
This flexibility of coverage, costs and investment choices makes crafting solutions for protection and tax effective saving an attractive tool for consumers and advisers alike. It has application for both personal and business solutions. For a frank discussion feel free to get in touch!