Helping Clients Reach Financial Security
"No Matter What"
Buying Life Insurance is similar to
buying a home, a tax shelter investment as your equity continues
as you make monthy payments.
The secret of universal life
(UL) can be found in two related areas:
Two Powerful Components
Money Out Later
How Universal Life Works
The Side Fund
Premium Survey contact advisor
Its low cost of insurance
relative to the costs associated with other investment strategies including
The tax status given to UL under Section 148 of the Canadian Income Tax Act.
What is special about universal life is that it is a life insurance policy offering superior investment growth and inexpensive protection. Its special tax treatment allows the universal life investment growth to often exceed the growth of the same amount of funds in a conventional investment even after the costs for the insurance are deducted.
The graph below illustrates this point. It shows the cumulative taxes paid out on a conventional investment exceeding the cumulative insurance costs. The choice is yours. You can pay out the larger sum in taxes over the years or you can accept the insurance costs and not pay taxes as your money accumulates.
Just what is the special tax treatment that gives universal life this advantage? Tax-exempt growth and tax-free payout at death are the answers!
Under the Income Tax Act, funds invested in a universal life plan accumulate on a tax-preferred basis. However, if you hold conventional investments in Canada outside your RRSP, like equities and GICs, you are taxed on the growth. Consequently, you lose some of those investment earnings to taxes. And those taxes are lost funds that would have earned more money the next year and the next year and so on. The result? The tax-preferred universal life plan is often able to accumulate more funds over the years even after the costs for insurance are deducted. But that's not all. As a life insurance policy, any death benefits are always paid out completely tax-free.
Does that mean universal life will always work for you? With a complex question that involve taxes and investments, there are never any simple answers. There are just too many variables like your age, tax bracket, investment choices, risk tolerance, withdrawal strategies, etc. Universal life can perform magnificently for one person's financial situation and not so impressively for another's. But this question can be answered with the powerful computer programs running on our site. You have to "check your own numbers" to find out whether it works for your specific situation. And remember, we are always available to answer your questions. Just call our office at the number listed on this site.
To begin, if you are a newcomer
to UL, we recommend that you click Next now
to gain a greater understanding on how universal life plans work. Follow
the sequence through to the end. You will learn about using computer projections
and then be guided through a number of wealth management strategies that
will help you decide if universal life works for you. By the end of your
visit, you will have your answer.
The two powerful components of universal life are term insurance for protection and a wide range of investment options. Term insurance provides an inexpensive death benefit. The savings element is provided by a variety of separate investment accounts.
You select the combination of investment accounts you want. These investments vary:
Guaranteed Interest Accounts
(similar to GICs),
Accounts linked to equity indexes such as the Standard & Poor's 500 Composite Index. If you elect, for example, to invest some of your funds in an account linked to the S&P 500 index, then those funds for any year would reflect the growth rate of the S&P 500.
Instead of accounts linked to outside indicators, some companies use mutual funds or segregated funds. (A segregated fund is a life insurance company's version of a mutual fund.) All of these choices provide excellent opportunities for growth and diversity
Money Out Later
The longer you leave your money to accumulate in a universal life plan, the more you maximize your opportunities for tax-deferral. Before removing funds it is best to consider the various types of investments that you have in your portfolio. This allows you to utilize the most tax-effective withdrawal strategy.
Ideally, you want to remove the money from your investments starting with the plans which have the lowest potential for tax-deferral. You have three major classes of investments:
non-registered assets, such
as stocks, bonds and mutual funds;
registered assets, such as RRSPs and RRIFs;
a special asset class, universal life.
Generally, if withdrawals are made or investments are liquidated:
Fifty per cent of deferred
capital gains will be included in taxable income. Non-registered asset
withdrawals are usually not taxed unless there is a deferred capital gain.
One hundred per cent of registered assets will be included in taxable income.
Universal life withdrawals are usually not taxed in the early years, but by the 25th year 100% of any withdrawals will be included in taxable income.
Therefore, generally the recommended order for taking money out later in life is:
Universal life funds should be withdrawn last because there are many opportunities to get access to the cash without paying any tax. These opportunities include an Early Death Benefit, the Disability Benefit Payout, and by using the plan as collateral for a bank loan. (The bank loan concept is one of the Wealth Management Strategies on this site.)
When you are planning your withdrawals, keep in mind that the government
forces individuals to make minimum mandatory withdrawals from RRIFs starting
at age 69. You may wish to consider this when you are determining withdrawals
from non-registered funds.
All funds deposited into a universal life plan are called premiums. When a premium is deposited into a universal life plan a small deduction is made for provincial tax. This tax ranges from about 2% to 4% of the premium deposit, depending on the province where you live. The remaining net premium is then deposited proportionately into the various investment accounts you have chosen. At the start of each policy month the cost for the term insurance, any administrative charges and charges for any optional benefits you may wish to add are deducted.
With UL, the value of all
your investment accounts at any given time is known as your eUL Account
Value. Over the years, your tax-sheltered investments grow and so does
your UL Account Value. In the event of death, your beneficiaries receive
the term insurance proceeds plus the value of all your investments in the
UL Account Value.
Universal life has a safety valve. Growth in a universal plan can be so high that the eUL Account Value occasionally exceeds the allowable limits for tax-deferment under the Income Tax Act. Companies monitor this situation carefully and when this happens the excess funds are usually transferred to a special side fund. With eUL it is called Express Account.
This fund is outside your
universal life plan. Excess monies are transferred to the side fund on
a temporary basis. The insurance company monitors the allowable limits
from year to year and transfers monies in the side fund back to your universal
plan as soon as the allowable limits permit it. Interest earned on monies
in the side fund are subject to annual taxation.
Maximum growth in a universal
life plan is achieved using compound interest, tax-deferment and time.
Therefore, you should view the longer term values of universal life in
deciding whether it is right for you. Another reason for taking a long
term view is that universal life plans have surrender charges in the early
years. These usually disappear by the end of the tenth year, so by keeping
your plan until then you avoid all surrender charges.
UL Tip If you
need cash for an emergency, consider a policy loan. You will not incur
any surrender charges.
Optional Benefits (also called riders) may be added to enhance the insurance coverage or to protect additional lives under the same universal life plan. These benefits are not automatically included in the plan. If you decide to add an optional benefit, a deduction is made from the eUL Account Value each policy month to cover the cost.
Optional Benefits can be a quick, easy and cost-effective way of adding diverse coverages if you have a need for them. For example, under an eUL plan these options include:
term insurance to provide
further protection on the insured(s) and to cover additional lives;
term insurance to provide additional coverage equal to the sum of all premiums paid — consequently, when the death benefit is paid, all premiums that have been made are also returned to the policyowner;
term insurance to provide an annual increase in the initial death benefit equal to the percentage increase in the Consumer Price Index (CPI) or to a fixed annual increase of up to 8% per year;
children's term insurance to provide modest amounts of coverage for children, usually from ages 15 days to 25 years;
a guarantee to continue regular deposits into the plan even after a policyowner becomes disabled or dies;
an additional lump sum payment if the cause of death is accidental.
UL Tip The reason that
optional Benefits are cost-effective is that there are no fees or administrative
charges attached to these benefits. Under most UL plans there is only one
administrative fee regardless of how many Optional Benefits you add.