Insurance: Beware Of Universal Life II

In my last article, I explained the basic differences between term and permanent insurance. Permanent insurance such as Whole Life, Universal Life, Equity-Indexed Universal Life and Variable Universal Life is regularly promoted as the perfect retirement vehicle or the new way to build wealth. This week I will expose the fallacies of those arguments.

First of all, I believe that the need for life insurance should be met in the most economical way possible. With universal insurance, where life insurance is combined with investing, you end up paying too much for the insurance while earning too little on the investment. It’s the worst of both worlds. Term insurance allows you to purchase the life insurance you need at a lower cost, while giving you the flexibility and control over your investments.

Universal policies unnecessarily lock you in. You’re committed to paying a high annual premium. For instance, the annual premium on one million dollars of universal life for a healthy, 45-year old non-smoking male is around $8,000. That’s $8,000 each year---for the rest of his life.

On the other hand, the annual premium for one million dollars of 20-year term insurance is about $1400. That’s a difference of $6,600 each year. With universal insurance, most of that additional premium builds the cash value of the policy. But because of administrative and other fees, the amount added to your cash value each year is reduced. By the way, has your agent mentioned there is a way to buy no-load universal life insurance?

Insurance agents tout universal policies as a wonderful investment vehicle. They’re not. Better returns can certainly be found elsewhere. Many of these policies are pitched to people in their prime earning years, most of whom are raising their families.

These investors will earn a far better return by first paying down their debt. That’s a guaranteed return, of up to 20% on credit card debt. For those without debt, any extra money they have is better used for 401Ks, IRAs, etc.

The tax benefits heavily promoted as a major benefit of universal insurance are suspect as well. It’s true that money drawn out of these policies for retirement spending isn’t taxed, but that’s because this money is actually a loan. In essence, you’re borrowing your own money. And since it’s a loan, it has to be paid back.

If you hold the policy until you die, a portion of the death benefit is used to pay back the loan. If you surrender that policy, the cash value is used for that purpose. Suddenly that money isn’t tax-free. Just like you may have to pay capital gains taxes when you sell your home, you will have to pay taxes on the amount of the cash value that is greater than the amount you paid in premiums.

Last of all, you need to be aware of the tremendous financial incentive agents have in selling universal life insurance policies. Commissions on universal insurance are 70% or more of the first year’s premium, then 5% of the premium each year after.

One of the most egregious sales tactic used to promote universal policies as an investment is that you should take the equity out of your home and ‘invest’ it in a universal life insurance policy. The argument is that your home equity is an asset that should be used, not left dormant. The tax benefits are also touted—the transfer is tax-free, the growth is tax-free and the distribution is tax-free! That’s triple compounding, they say.

Do not fall for this trap. Frankly, those recommending it should lose their licenses. The arguments used to support this scheme are all smoke and mirrors. The tax benefits are bogus, you lose control of your money and the agent earns a big fat pay day.

Nor will the earnings be what you expect. Most of the time you will end up paying more in interest on your home equity loan than you will make in the policy. The distribution is tax-free, but all death benefits paid on life insurance policies are tax-free. So you can leave the equity in your home, buy a term life policy and have the same tax-free distribution benefit.