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Universal Life Insurance

This article was written by in Insurance. 16 comments.

Every once in a while, I receive financial questions from readers. I am not a financial adviser, so I usually suggest those needing significant assistance with their financial decisions to seek the advice of a professional. However, I don’t mind answering general questions that might be helpful for a wider audience. If you have any questions, contact me. If there’s anything I’d like to address but I’d like to learn more about myself, I have a strong network of colleagues who can add facts and expert opinions.

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Today’s question comes from a frequent participant in Consumerism Commentary’s discussions, and focuses on a topic I don’t usually cover, life insurance.

Flexo, I recently read a book called Tax Free Retirement by Patrick Kelly and the author was selling the idea of buying Universal Life Insurance as a way to build your retirement fund. I’ve been doing research on Universal Life Insurance (pros and cons). What are your thoughts on Universal Life Insurance, and is it something you recommend people to do?

What is universal life insurance?

It’s worthwhile to describe life insurance in general, although I will address the specific question about retirement funds later in the article.

The primary parties when it comes to insurance are the insured, the beneficiaries, and the insurer. Life insurance policies offered by the insurer protect the income of the insured, so that if the insured passes away, the beneficiaries, who relied on that income in order to survive, can continue receiving income or a lump sum payment. For example, the head of a household or all income earners in a family may buy life insurance to protect their children. Life insurance benefits could help pay for funeral costs, medical bills, and the normal expenses of everyday life for the beneficiaries.

Life insurance comes in several flavors. The most common and basic is term life insurance. This is a typical insurance policy that is based on a set number of years. During that period, the insured will pay premiums and be protected, but at the end of the term, the protection ends. The nature of insurance means that someone could pay into a policy for several decades, and if that insured individual continues to live and stay healthy, she’ll never have any benefit other than peace of mind. At the end of a term, insurers offer an option to renew the policy.

In an effort to reduce the risk of non benefiting from years of paying into a policy, insurers came up with different types of policies, usually including a savings or investment component to help insurers mitigate the risk because in these scenarios, the chance of paying out benefits is closer to 100 percent. These are often called permanent life insurance policies, and there are several different plans designed to suit customers’ needs. Universal life insurance is one form of permanent life insurance, like whole life insurance.

Universal life insurance

Universal life insurance provides some flexibility in the premium payments, the amount of money the insured pays to the insurer, usually on a monthly basis, to pay for the coverage as well as fund the savings component. The savings component is the cash value portion of the insurance policy; it’s basically a savings account. The insured can withdraw or borrow money from the cash value portion of an insurance policy. Because of this benefit, the premiums are much higher. Sometimes, the difference in premium is a factor of ten. Is the savings portion worth ten times more than an insurance policy on its own?

Because insurance companies usually offer low rates on the savings portion, and unlike money market funds there are no regulations that describe what the insurance company can do with your “deposits,” insurance companies often invest the money at a higher interest rate, making money on the spread between their investment returns and the low interest rate they offer their insurance customers.

When you withdraw or borrow money from a universal life insurance policy, it reduces the amount of benefit your heirs or beneficiaries will receive. This reason alone is enough to steer people away from this type of coverage.

An interesting benefit of universal life insurance, beyond the similar whole life insurance, is that the insured can use the interest earned on the savings component to help pay the monthly premiums. Also, there is a type of universal life insurance called variable universal life insurance. With this variable plan, the savings portion earns a variable interest rate. With whole and some universal life insurance policies, the rate of interest you earn is locked in for the remainder of the policy.

Variable universal life insurance is one of the most flexible products you can buy to protect your income stream, but it comes at an even higher cost than the type f unversal life insurance described above.

Compared to universal life insurance, variable or not, you may be able to generate your own returns in savings or investment that are better than the returns you’d receive by including a savings portion in your policy. If you’re a savvy saver and investor, you may want to leave your investments separate from your life insurance policy and opt for term life insurance. If you appreciate consolidating your savings with your insurance policy and are not concerned with a significantly higher cost, it might make sense to opt for this type of coverage.

Can a universal life insurance policy build your retirement fund?

The savings component can make this a tempting option. There are three major drawbacks to this approach, and because of these reasons, I would not use a life insurance policy of any type to increase my planned income during retirement.

  • Any retirement income you need and withdraw reduces the value of the benefits your heirs will receive, as mentioned above.
  • You can get better investment options by opening an IRA at a discount brokerage.
  • You’ll be paying much more for less potential performance than other retirement options. Even a 401(k) could cost much less.

For readers: Do you have a universal life insurance policy and are you happy with the insurer so far? Have you had any experiences collecting benefits from a policy?

Updated October 21, 2015 and originally published August 22, 2011.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 16 comments… read them below or add one }

avatar 1 Anonymous

If you are already making full use of your 401(k), ROTH 401(k), IRA, ROTH IRA, and have reasonable term life insurance coverage, Universal Life can be a fit for you.

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avatar 2 Anonymous

“If you are already making full use of your 401(k), ROTH 401(k), IRA, ROTH IRA, and have reasonable term life insurance coverage…” Go out – have a good time – enjoy life. Unless the agent is a relative or friend you want to support and enrich, you’ll probably just be filling up their desk with little awards and trinkets given out when the bosses are doing really really well. (I said that? – must be Monday)

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avatar 3 shellye

I’ve always heard that universal life policies are a rip off, so I’ve never pursued one. I do have an excellent term life policy that is reasonably priced.

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avatar 4 qixx

I have found that some Universal life and Whole life policies will accept some people that can’t get Term policies. My wife is actually one. She has a certain medical condition that we can’t find anyone that will give her a term policy on (except State Farm – if she has a State Farm Whole Life policy). Universal life or any other permanent life policy is better than no life insurance policy. I’d say get term life if you can. If you can’t then it might be worth a look as these less desirable life policies.

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avatar 5 Ceecee

With no dependents, I’ve opted to forego life insurance. If I’d had kids, I might have gotten a term policy until they were grown. I think we are programmed that you must have life insurance—-but if no one depends on your income, why? For retirement, I prefer a Roth IRA.

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avatar 6 Anonymous

Roth IRA is outstanding, but Roth IRA caps your contribution at $4,000/year currently. That’s a meager sum to put away for any retirement plan. I find that Universal Life policies are actually outstanding form of savings for retirement. There is a compound interest component (without any taxation) that really impacts the growth of your cash values, and then allows you to withdraw them during retirement years. It’s best that you speak to a professional life insurance agent who can properly guide you through how to strategically take advantage of one of these policies. I have a Universal Life policy and based on my company’s guaranteed performance, I will retire with an additional $2,000,000. Based on their non-guaranteed performance, I will retire with an additional $3,500,000 (only $850,000 was my contribution). My insurance agent has walked me through how to minimize my taxation on the growth – and in comparison, my life policy completely outperforms my 401k.

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avatar 7 Anonymous

Not that it takes away from the point of your comment it is likely you are talking about whole life (possibly variable univ life, but most likely WL).

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avatar 8 wylerassociate

Very good column flexo. I think the allure of universal life insurance is tempting but if I have to choose between the 2, I would stick with a 20 or 30 year term life insurance policy.

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avatar 9 Anonymous

I have a friend who just bought universal life for his newborn baby as a vehicle to save for college. I don’t know much about ULI except for the fact that the fees are ridiculously high. Anyone know the pros and cons of this? He said he wants to do this as opposed to a 529 plan, as his “financial adviser” said this is a better option.

He’s a good friend and pretty open, so I’m not shy about having a talk with him about how much of a mistake this might be.

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avatar 10 Anonymous

Ask him again, I bet he actually has a Whole Life rather than a VUL

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avatar 11 Anonymous

If the poster was referring to fees as opposed to premiums, then it is more likely that this IS a variable type product. Whether this is variable whole life or variable universal is very secondary. Life insurance policies with cash value are typically some combination of the words [Variable|Fixed(or Indexed)] + [Universal|Whole].

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avatar 12 Anonymous

Great post on Universal Life Insurance. A few things I would like to add. If you are planning on using these policies as any sort of investment, you absolutely have to over fund them.

They are generally designed to have you pay the minimum premium to carry the policy out to age 120. The cash value you see in the middle years are really meant to contribute to your premiums at your older ages. That being said, if you take out a large sum of money, the policy will not last as long as you may need it.

The more you look at universal life the more it looks like a very long term policy. Instead of a 20 year term, you are purchasing a 60 year term or 80 year term. The cash you see will not be there as you get into your older years. I don’t want to guarantee on it but I would bet on it. This doesn’t make them bad but you have to understand how they work and if they fit exactly what you are trying to accomplish.

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avatar 13 Anonymous

No one mentioned Indexed Universal Life Insurance. Not nearly as risky as VUL and less expensive to manage, yet IUL are a little more to manage than a Fixed UL. You can have more than one IUL also. Not to mention 401’s, 403’s, IRA’s, Mutual Funds, CD, Annuities, Municipal Bond Funds, etc need to perform on average at 8.25% – 13.5% (depending on which) to match what a IUL can achieve at 7.75% over a 35 year period !! You can get 7% – 8% returns over 20 – 30 yrs on an over-funded IUL, just keep TEFRA, DEFRA and TAMRA in mind. Get the policy for the death benefit you want ($100K, $250K, $500K) and fill the pot quickly, BUT without creating an MEC and let it ride for 30yrs (if you can) and enjoy a $50K+/yr tax-free retirement. And still pass a sizeable death benefit that’s income-tax free to your heirs. Read “Missed Fortune 101” by Douglas R. Andrew, especially the last 3 chapters (10, 11 and 12) !!!

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avatar 14 Anonymous

I actuallly have a VUL and I love it. But I do have other retirement accounts. I have plenty of options to choose from for my subaccounts. And so far they have done well. Love the fact that I can increase or decrease my premiums. My policy part of my retirement stratedgy. Similar to a Roth IRA, my withdrawals will be tax-free as I plan to keep the policy enforce. Also, my cost has dropped. Some people don’t realize this but at times your cost of insurance will decrease but so many people are used to buying term with a level premium that the overall cost is priced into the premium.

With that being said, a universal policy may not be the right fit for everyone. As an investment advisor, it’s important to take a look at your entire financial picture before implementing such as policy.

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avatar 15 Anonymous

The point of universal life is that it protects people from the ups and downs of the market. If you put your money into an IRA or a 401K and the market goes down, you will loose money. With IUL’s the loss years become a zero return. This means that if you can cut out the losses, the gains are on your base. Nobody ever lost a penny of value in an IUL because the market went down. The worst that could happen is that they get nothing. Which is better, nothing or the 29% loss that the S&P suffered in 2001?

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avatar 16 Anonymous

I know this is an old post, but in researching the book that triggered the article, I stumbled across this, I have several problems with this article. I think it’s very clear that the author did not actually read the book while trying to respond to the question, but I understand that the OP never asked anyone else to read it. Regardless, about the reasoning against universal life policies, I’m a little confused.

-Any retirement income you need and withdraw reduces the value of the benefits your heirs will receive, as mentioned above.
This isn’t a negative. If you put money into a UL for the purposes of growing an account and not the death benefit, lessening the death benefit that you weren’t aiming for in the first place is not a loss to you. Any death benefit in the policy would be a BONUS to the person putting money into the UL. For someone putting the money into an IRA, 401k or any other account with special tax treatment, wouldn’t any amount withdrawn and spent not go to any survivors anyways? Calling that a negative is double counting money withdrawn as both spending money and inheritance money, which isn’t true for IRA’s or 401k’s either.

– You’ll be paying much more for less potential performance than other retirement options. Even a 401(k) could cost much less.
Comparing premiums to fees in such a way paints a biased picture. If one should die prematurely, the death benefit that would pass on to survivors could much better leverage the money paid in premiums as opposed to having that money accumulate interest. The risk associated with the death benefit that the insurance company assumes is part of why premiums are more costly than fees charged for investing. A fairer way to present the point might be to say:
“You can pay higher premiums for a death benefit in addition to lower potential and lower risk in a UL (VUL’s wouldn’t fit in this statement anyways) or pay lower fees for a higher potential account with higher risk.”

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