Universal life insurance may be something you've heard about on TikTok or in the news lately, especially a type called index universal life insurance.
You may have heard that it's a good investment strategy and that it's essentially a "cheat code for the wealthy."
There's also another side of the story: that universal life insurance costs way more than the cash value it delivers, and that it's full of hidden fees and fine print.
In this post, our certified life insurance advisors deliver the straight facts about the pros and cons of universal life insurance in Canada, how cash value works and whether index universal life insurance is actually all it's cracked up to be.
Universal life insurance is a type of permanent life insurance coverage that will cover you for your whole life, as long as you keep paying the premiums.
Some of what you pay goes towards the life insurance itself, while another portion is divided between savings and investment components.
Insurance companies introduced universal life insurance policies in the 1980s. They’ve sold them widely since then, though the popularity of universal life has taken a tumble, as The Wall Street Journal reports.
The problem is that these policies are often confusing to buy and own.
There are many ways you can customize them, but you also need to monitor them closely to make sure the investments are performing and adjust them as needed.
If the investments continue to underperform, your premiums could go up and you may not be able to afford your policy, meaning it would expire.
In fact, almost 88% of universal life policies never pay out. This is because people let their policies lapse, often because they can’t afford the premiums.
Want a quick primer? Licensed advisors Eric and Tobin walk you through the ins and outs of universal life insurance in this video.
The accumulation of cash within your universal life policy is called the cash value.
The cash value portion of your policy can either grow or suffer losses as the investment portion fluctuates.
This cash value portion is often what attracts people to universal life insurance, as they may know just enough about it to realize you can take money out of the policy by withdrawing or borrowing funds.
Universal life policies are not worth it for most Canadians. While universal life is supposed to provide financial protection for your family and build wealth, they're not very effective as investment vehicles.
The investment portion of universal life isn't known for having great returns, and definitely not as good as using tax-advantaged accounts like RRSPs and TFSAs that have investments.
Another drawback: there is a forced savings component (cash value) and if you pass away before you spend it, it's gone. Your beneficiaries only get the payout you originally bought; not the cash value.
Universal life insurance and whole life insurance are both types of permanent insurance coverage, but they differ in cost and flexibility.
Let’s imagine each of these types of insurance is a bucket to hold your money.
With this type of insurance, you pay your set premium and the money in your imaginary bucket stays consistent. The money accumulates in your bucket, with part of the money going to insurance premiums and part of it being invested.
This can be seen as the safer of the two options, as your money typically goes into a low-risk fund you won’t need to worry about. In fact, your insurer will guarantee a rate of return.
With universal life insurance, the amount in the bucket can fluctuate. Why? The cost of insurance could go up and erode what you’ve put in.
It’s also possible for investments held in the bucket to do poorly, causing you to have to pay a lot more in premiums. If you can’t pay the required amount, your policy could lapse.
With universal, you also have some flexibility in what your funds are invested in. You also can choose if you want to pay your premiums monthly or annually.
Whole life insurance has a steady monthly cost that stays the same over time. It can make it more expensive upfront, but it’s stable.
Universal life insurance, on the other hand, can start out more affordably but will get more expensive as you get older.
When you pay your universal life insurance premiums, those fees get split into two parts:
The idea is that you’ll have more flexibility in choosing how high your premiums are within a specific range set by the insurer.
This range will always cover the cost of insurance, otherwise known as the death benefit, and the cost to deliver the service to you through administrative fees.
If you pay more than the minimum premium payment, the additional amount is added to your cash value.
Universal life insurance can provide lifelong coverage, which can feel reassuring if you’re trying to provide a financial cushion for your family after you’re gone.
The death benefit, or the amount paid to your beneficiaries, is received by them without tax implications. Some policies accumulate cash value over time.
This type of coverage usually offers flexible premiums that allow you to monitor and adjust how much you’re paying and offer you the opportunity to access the cash value in the policy.
You’ll always need to make the minimum payments, though, to keep the policy from lapsing.
Read more about how life insurance works in Canada, from term to whole to universal policies.
Universal life insurance is a type of permanent insurance, which means they are intended to last for your entire life and won’t expire as long as you keep paying your premiums.
These policies typically guarantee a rate up to a certain age. While this age might be 100 years old, you may have to pay a significant amount to keep the policy in force if you happen to live past that age.
It’s a good reason to monitor universal life insurance coverage carefully, as you’ll need to not only keep the payments up to date but ensure you’re paying the right amount.
If your policy lapses due to non-payment, you’ll need to start over with a new policy at a later point in life, which could be expensive.
Universal life insurance tends to be both expensive and complex to manage, so it’s not the best choice for most people who need affordable payments and a simple policy they can understand.
A universal life insurance policy might be a good choice for someone who wants:
There are two types of people who might be a good fit for universal life insurance:
That said, most young people aren’t in those high tax brackets. Also, life insurance policies now have less tax-exempt room because of new tax rules in Canada, which came into effect in 2017.
This means less room to fund policies and less tax-free benefits upon death, making universal life insurance policies less attractive.
The truth is that most Canadians need term life insurance, at least those who have dependents who rely on them financially.
Term life insurance covers you for the years you need it the most, when your kids are young and/or your debt payments the highest.
Not sure how much term life insurance you might need? Check out our Canadian life insurance needs calculator.
There’s a lot to learn before seriously considering a universal life insurance plan. So what are the disadvantages of universal life insurance? What are the benefits?
Let’s have a closer look at how these policies stack up by comparing the pros and cons.
1. Lifetime coverage
As a type of permanent insurance, your universal life insurance policy will remain active as long as you pay your premiums.
2. Flexible premium payments
Typically, you can make adjustments to the coverage amount and premium payments over time, offering flexibility as your life or income changes.
3. Cash value accumulation
As you pay your premiums, a portion of the money goes into an account that represents the cash value of your policy and can earn interest over time.
4. Tax deferral benefits
As with most life insurance policies, the death benefit paid out to your beneficiaries is tax-free. However, the interest earned on the cash value portion of your policy is tax-deferred, which could be a benefit in your situation.
5. Variety of investment strategies
There are different types of universal life insurance, and these options give you some flexibility in choosing how the investment portion of your policy is used.
1. Premiums can be expensive
Universal life insurance isn’t an affordable choice for most people. It can be prohibitively expensive, making it hard for policyholders to keep up payments to keep the policy active.
PolicyMe's term life insurance rates are some of the most affordable in Canada; and couples save 10% in their first year when they apply together.
2. Cash value may be limited
Your insurer may cap your cash value returns or how much you can invest based on tax laws, so ask about things like the “participation rate” or contribution limits before signing up.
3. Careful monitoring is required
There’s no hands-off version of these policies. You’ll need to monitor your policy closely to make sure you’re paying the right premiums and your cash value doesn’t get depleted. If this happens, you could lose the policy.
4. Return on investment portion not always attractive
While the idea of an investment portion is appealing, it’s wise to look carefully at the interest rates you could earn. If you’re interested in investing for your financial future, you’re better off with a traditional investment account like a TFSA or RRSP.
5. Building cash value takes time
Cash value is one of the features most people are familiar with when it comes to universal life insurance, but it takes time to build it up. It’s wise to get a clear picture of how long it will take before you’d ever be able to withdraw or borrow against your life insurance in an emergency.
6. Proposed flexibility could require a health exam, causing increased premiums
These policies are often sold as flexible coverage you can adjust as your needs change over time. This may sound like a good thing, but be aware that raising your coverage may require a health exam, which could trigger higher premiums.
Universal life insurance is not a good investment strategy for most people.
In most cases, you’d be better off putting your money in your RRSP or TFSA.
If you’re a high-income earner who has maxed out your other investment options, you could consider universal life as an option. But wiith limited returns, it’s not typically a great investment.
There are real concerns with how these policies have been sold as investments. In most cases, customers simply haven’t understood how the policies work and haven’t monitored them as closely as needed.
In the worst cases, the returns are overestimated when the policies are sold, leaving people with the impression they have more security than they actually do.
Then as time goes on, premiums go up, policies are underfunded, and people suddenly can’t afford to keep the policies active.
There are a number of different types of universal life insurance policies. While they all offer lifelong coverage, there are differences in how they are structured.
As well, across the different types, there’s a wide range of investment options for you to consider.
Let’s take a closer look at guaranteed universal life insurance, indexed universal life insurance, and variable universal life insurance.
Note: These types of universal life insurance often have proprietary names, so you may need to do some research to make sure you know exactly what kind of policy you’re looking into.
Guaranteed universal life insurance offers you the opportunity to have a universal life policy with little to no cash value. It might be offered as a way to get the lowest premium payment possible on universal life coverage.
However, at that point, the policy more closely resembles a whole life policy, so that would be a better choice.
And even more noteworthy, if you remove the cash value component, this policy ends up being even closer to a term life insurance policy, which would likely still be a much more affordable choice.
Canadian example: Manulife’s Security UL
Indexed universal life insurance policies are similar to standard universal life insurance policies, with one key difference.
In an indexed universal life policy, the investment growth is tied to the performance of an index, such as the S&P 500 or the NASDAQ 100.
In these policies, your cash value could be partially invested in a fixed rate investment account that is lower risk and partially in an account tied to the performance of an index, which is higher risk.
Note: Indexed universal life insurance really comes down to an insurer’s investment options. If they offer index funds, you get an indexed UL policy. But, there are lots of other investment options like stocks, equities, bonds etc.
Variable universal life insurance works similarly to an indexed universal life insurance policy.
Again, your cash value portion is invested, but in this case, in investments that are similar to mutual funds. You’ll be able to choose how much is invested in each and make assessments based on how the funds have performed over time.
Just like mutual funds, each investment fund will have management fees associated with it, so it’s a good idea to investigate fees carefully to ensure they don’t end up cannibalizing your returns.
Some life insurance policies, like universal life, build up cash value over the life of the policy. This cash accumulation comes from you paying more than the minimum premium payments plus some growth over time within the account.
This cash value is often sold as a benefit, with the assertion that a policyholder can take or borrow money from the policy in case of emergency. You could do this through withdrawals, loans from the policy, as well as surrendering, or cancelling, the policy.
There are a few things to know about taking money from your cash-value life insurance policy:
The cash value in a universal life policy is a benefit for you while you are alive, should there ever be a time you can take advantage of it.
What your beneficiaries receive is the death benefit on the policy, and that’s likely all unless you’ve paid extra to have the cash value maintained.
So what happens to the cash value that has built up in your policy? It goes back to the insurance company when you pass away, even if you’ve been paying into the policy for years.
Universal life insurance isn’t for everyone. If it doesn’t sound like a fit for you, you’re not alone. Let’s have a look at some of the other insurance options you can consider.
For example, you may only need coverage for 10 or 20 years while raising a family or caring for older parents. Then, at the end of the term, and when you no longer have dependents to care for, you can allow your term insurance policy to expire.
In fact, term life insurance is the fastest-growing type of individual life insurance in Canada.
In 2020, term life coverage grew 39% while universal life coverage grew 13%, according to the Canadian Life and Health Insurance Association.
At PolicyMe, we only sell term life insurance because we believe that’s what most Canadian families actually need. That’s why we wrote a straightforward guide to term life insurance that covers who needs it, who doesn’t, how much it costs and more.
Both whole life insurance and universal life insurance are permanent policies, so they have some similarities. They typically cover you for your lifetime, and both have cash value and an investment component.
Both tend to cost a significant amount more than term life insurance for these additional features.
If you meet the general criteria for a permanent policy, with a high enough income and other traditional investments maxed out, then a good way to decide between them is to consider how they differ.
If you know you won’t monitor the policy to ensure you are paying the right amount over time, a universal policy likely isn’t for you. A whole life policy would better suit your needs.
However, if you really want to be able to make decisions about what happens to the investment portion of your policy, you may want the flexibility of a universal policy.
Comparing universal life insurance to term life insurance is where it really gets interesting.
While these are two common types of life insurance, they are strikingly different in how they work and how much they cost.
Universal life insurance is permanent life insurance coverage that comes with other components such as cash value and some investment and tax-deferral benefits. These additional components make it seem that it offers broader coverage, but just be aware that you may or may not ever benefit from them.
Premiums tend to be a lot higher for universal policies, which can also be an obstacle for people trying to afford the payments over the long term.
Term life insurance covers you for a specific period of time, such as while you have dependents like children or older parents. You may choose a 10 or 20-year term to ensure you are protected while this need exists.
Then as your needs decrease, so can your coverage. Few people have coverage needs that stay level over their entire lifetimes.
Term life insurance is far more affordable, meaning you can likely opt for a higher death benefit while still being able to afford the payments.
Have a look at a term life and universal life cost comparison to see the difference.
PolicyMe makes it easy to get term life insurance. Just get a quote, apply online and find out if you’re approved in 20 minutes or less.
Universal life insurance has some appealing aspects but also a lot of complexity.
Complexity is one of the biggest pitfalls with universal life insurance.
It’s often difficult for people to assess the value of the additional components that drive up the cost of the premiums. It also requires careful monitoring that most people simply don’t have the knowledge or time to do.
Most people who have owned this type of life insurance in the past would have benefited more from a term life insurance policy and outside savings and investment accounts.
Some people already own universal life policies and realize that it doesn’t fit their needs, or that they can’t afford the premiums and risk having the policy lapse.
First, you need to understand what you have. Review your policy and coverage in detail. Book a consultation with an advisor who can tell you what the numbers mean and what has happened so far with your policy.
You’ll want a snapshot of premiums paid and how much cash value has accumulated. You’ll also need an updated projection of future numbers.
An advisor should be able to help you assess if your policy is still growing cash value, or if the premium portion has grown so large, due to your age and the cost of covering you now, that it’s starting to consume the cash value.
Remember that there typically are no guarantees, so you’ll only be able to work with what’s happened so far and the best projections that can be made.
You’ll also want to review the consequences of surrendering, or cancelling, a policy. There may be potential tax implications or policy fees that you’ll need to pay.
If you stop paying the premiums on your universal life insurance policy, a couple of things might happen.
First, the premiums may be paid from the cash value of your account to keep the policy in force. This only works if there is enough cash value in the policy to do so.
It might keep you covered in the short term if you aren’t able to make your payments but be cautious. If you use up the account’s cash value to pay premiums and deplete the cash value accumulation entirely, you could lose your coverage.
If you want to stop paying your premiums deliberately, you can cancel your policy. You’ll receive what’s called the cash surrender value, or the remaining cash value in the account.
However, know that you’ll likely pay surrender charges, or a penalty for cancelling, and you must pay income tax on what you receive in the year you cancel.