Is universal life for you?

Universal life is the new kid on the block as far as life insurance goes, although it’s been available for several years. This is not pure insurance but rather a combination insurance/investing program that carries higher premiums and, not coincidentally, higher commissions for insurance sales people. The idea is that part of your premium goes towards your insurance protection, while part is directed into an investment fund. The investment portion grows tax-sheltered, and forms part of the death benefit when you pass on.

These policies are more flexible than standard whole life policies, but they are also more complicated and extremely difficult to assess on a comparative basis. The key to making comparative judgments is to attempt to separate the two components of the policies you are considering. Find out how much of your premium is going to pay for the insurance coverage and how much is directed to investments. All else being equal, the greater the percentage of the premium that is invested on your behalf, the better.

Make sure that the initial quotes assume a basic premium only. Universal life plans allow you to increase your premiums substantially, to maximum level set by the federal government. The extra amount is added to your investment pool. 

Some people who have maximized their RRSP contributions use universal life to increase their tax-sheltered assets. If you think you might want to do this, you’ll need to pay attention to a little-known rule that can severely restrict your extra payments. It’s sometimes referred to as the 10/250 rule or the anti dump-in rule. The effect is to put a ceiling on your investment payments after the 10th year of the policy of 2.5 times (250 percent) of the total value of the fund three years before. So if at the end of the eighth year of the policy, the investment fund is worth only $3,000, you can’t contribute more than $7,500 in year 11. The idea is to prevent people from tax sheltering large amounts of money late in a policy’s life.

For that reason, universal life is generally not a good choice for younger families who cannot afford large extra premiums. They’ll severely limit their ability to build a large tax-sheltered fund later on. They should start with term insurance.

However, for older people who have more money available, universal life is an option worth considering, especially if you have maximized your RRSP contributions. 

If you’re seriously considering a universal life policy, ask the agent for a complete list of the investment options available to you. Some companies offer a wide range of choices, from fixed-income securities to equity mutual funds from well-known firms. In other cases, the selections are very limited. As a general rule, the more options the better.

Also, be sure to ask whether all the selections are immediately available. Some policies only allow a limited choice until the investment account reaches a certain size, after which the list broadens considerably.