Universal life insurance and whole life insurance can be an attractive investment tool in the right circumstances.
Technically, the policies are life insurance policies, not investments, and the returns are generally slightly lower than mutual funds, but they have four significant advantages:
- Proceeds are life insurance and thus not taxable.
- The policy can specify a beneficiary and thus avoid probate fees.
- The value of the investment grows tax free.
- The policy is “creditor proof” because it isn’t subject to seizure by courts as other investments would be.
By paying more than the minimum premium, policy owners build up a surplus that can be put into various investments the insurance company holds on their behalf. The value of those investments is added to the face value of the policy when the insured person dies. That provides a tax-free payment of life insurance proceeds to the beneficiaries.
Since the life insurance company — not the policyholder — holds the investments the growth is not taxed the way other investments would be. This tax sheltering is similar to an RRSP, with the advantage that when the policy is eventually paid out on the death of the policyholder, there will be no tax on the proceeds.
You may also borrow money from the surplus in the policy at a low interest rate. This would allow you to finance your retirement from that surplus with tax-free money because the funds are in the form of a loan rather than income.
The loan is automatically paid off at death, reducing the insurance proceeds by the amount of the loan.
While the return on investment isn’t generally considered stellar compared to other investments because of the life insurance premiums that must be paid, these policies can be an attractive option if you need life insurance for estate planning purposes.
The actual life insurance cost (called the Cost of Pure Insurance) is very similar to term life insurance, and the policies offer the ability to accumulate a surplus that is invested to your advantage as the face value of the policies increase.
The underlying investments available in a life insurance policy have greatly increased over the past few years. Virtually any mutual fund is available through one carrier or another, along with annuities and GICs.
Talk to your financial advisor regarding these products if you think that you might benefit from universal life or whole life insurance.
Universal vs. Whole Life Plans
When discussing investments in universal or whole life insurance plans with your professional adviser, it’s important to know how the two plans differ.
Both contain four elements:
- Mortality Cost: The part of the deposit that covers the pure cost of the life insurance death benefit.
- Administration charge: This is the charge for administering the policy and premium tax.
- Savings or Investment: The amount remaining after the above two charges are deducted. You will be provided with an illustration of how your savings will grow, often called the Cash Value, Fund Value, or Cash Surrender Value of your policy.
- Return on the savings: This is the interest rate that is credited annually to the cash value in your account.
In addition, some policies guarantee that the costs will not change and guarantee a minimum return on investments.
Whole Life Insurance
These policies have a level cost that does not increase each year. Your first payment will be the same as your last payment. However, whole life policies disclose neither the mortality nor the administration costs.
Once those two costs are covered, the balance of the premium is the savings or investment portion. The returns depend on excess interest and investment earnings, savings in mortality costs, the operating expenses and the insurer’s board decision on what to pay.
Whole life policies also don’t disclose how they calculate returns on your savings portion and you cannot choose where the money is invested.
Universal Life Insurance
These disclose both the mortality charges and the administration charges, which are often guaranteed not to change for the life of the policy. These policies, in their newer forms, also offer a list of investment options that are similar in some ways to mutual funds. Some are even designed to reflect well-known funds and are even managed by mutual fund managers.