Universal Life Insurance in Canada: Good Investment Strategy or Bad News?
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- Universal life insurance is not designed for individuals seeking a "set-it-and-forget-it" type of coverage.
- Consider universal life insurance if you have already reached the maximum contributions for other investment options, such as a TFSA or RRSP.
- Term life insurance is generally a more suitable option for the average Canadian.
- For individuals seeking permanent life insurance, whole life insurance can be the optimal choice.
What is universal life (UL) insurance in Canada?
Universal life insurance, a form of permanent life insurance, provides coverage for your entire life, as long as you continue to pay the premiums. The premiums are allocated between the life insurance component and savings and investment components.
What is universal life insurance?
While TikTok might suggest that universal life insurance is a savvy investment and a “cheat code” for the wealthy, this isn’t always the case. The challenge lies in the complexity of purchasing and managing these policies.
Universal life insurance offers customization options, but it requires vigilant monitoring to ensure the investments perform well, necessitating adjustments when necessary. If the investments underperform, your premiums may increase, potentially making the policy unaffordable and leading to expiration.
In reality, almost 88% of universal life policies never pay out because individuals often allow their policies to lapse.
Here's a quick summary:
- You have the flexibility to adjust your premium payments, but insufficient payments may lead to a lapse in your coverage.
- Continuous monitoring is essential for universal life insurance.
- Continuous monitoring is essential for universal life insurance.
- For the majority of Canadians, opting for investment accounts such as TFSAs and RRSPs is generally more beneficial.
- Universal life insurance could be suitable for individuals who have exhausted other investment opportunities.
What’s the cash value of universal life insurance?
The cash accumulation within your universal life policy is referred to as the cash value. This cash value component can experience growth or losses based on the fluctuations in the investment portion.
The allure of universal life insurance often stems from the cash value, as individuals may be aware that funds can be withdrawn or borrowed from the policy. However, it is crucial to closely monitor your policy to ensure you are paying the correct premiums and prevent depletion of the cash value. Failure to do so may result in losing the policy.
What’s the cash value of universal life insurance?
For the majority of Canadians, universal life policies may not be a worthwhile investment. While intended to offer financial protection for your family and facilitate wealth accumulation, they are often deemed less effective as investment tools.
The investment component of universal life policies is not renowned for delivering impressive returns, especially when compared to the performance of investments within tax-advantaged accounts like RRSPs and TFSAs.
“Most Canadians won’t need to invest in universal life insurance, at least not until they’ve maxed out other investment options. Plus, the complexity of this type of policy makes it tricky to ensure their investment strategy will work over time.”
— Philippe Charbonneau, Licensed Financial Advisor
For the majority of Canadians, a more straightforward life insurance option is often preferable, and that’s where term life insurance becomes relevant.
Term life insurance provides coverage for a specified duration, typically ranging from 10 to 30 years. It offers protection at a lower cost without the added complexities of a universal policy.
With significantly lower premiums, you have the opportunity to invest the difference as you see fit.
How does universal life insurance work in Canada?
When you make premium payments for your universal life insurance, these fees are typically divided into two components:
1. **Coverage Cost:** One part covers the expense of your life insurance coverage.
2. **Savings and Investment:** The other part is allocated to savings and investment.
The concept is to provide flexibility in choosing the premium amount within a specific range set by the insurer. This range ensures coverage for the cost of insurance, known as the death benefit, and administrative fees for service delivery.
If you pay more than the minimum premium, the surplus amount is added to your cash value. While this cash value can potentially grow over time, it’s essential to note that any growth projections are forecasts, not guarantees.
This type of coverage typically allows for flexible premiums, enabling you to monitor and adjust your payments. It also provides the opportunity to access the cash value in the policy. However, making the minimum payments is crucial to prevent the policy from lapsing.
Does universal life insurance expire?
Universal life insurance falls under the category of permanent insurance, designed to provide coverage for your entire life, without expiration as long as premiums are consistently paid.
These policies usually guarantee a rate up to a specific age. If you live beyond that age, keeping the policy in force might require substantial payments.
In the event of policy lapse due to non-payment, restarting with a new policy later in life could be costly. Hence, opting for a senior life insurance policy in Canada might be a preferable alternative.
Who is universal life insurance for?
Universal life insurance is for someone who wants:
- Cash value that could be withdrawn or borrowed from over the life of the policy.
- Permanent coverage that lasts a lifetime.
- Flexibility to adjust premiums and death benefits over time.
- Control over where the investment portion is used.
“Universal life insurance is for those who want to be hands-on with their policy and their investments. It’s not a ‘set-it-and-forget-it’ kind of policy like term life insurance.”
— Philippe Charbonneau, Licensed Financial Advisor
There are two types of people who might be a good fit for universal life insurance:
- Younger people making a very high income, who don't need the money for decades and can take on more risk.
- Those in a high-income tax bracket who have maxed out their TFSA and RRSP and want to pass down an inheritance tax-free.
That said, most young people aren't in those high tax brackets.
Universal life insurance is often expensive and challenging to manage, making it less suitable for those seeking affordable payments and a straightforward policy.
Additionally, changes in Canadian tax rules since 2017 have reduced the tax-exempt room for life insurance policies, diminishing the attractiveness of universal life insurance.
In reality, most Canadians, especially those with financial dependents, are better served by term life insurance. Its more economical premiums allow you to save money and invest the surplus. After the term concludes, you can continue investing without being tied to a costly policy.
Pros and cons of universal life insurance
Here’s a quick glance at the pros and cons of universal life insurance:
Pros:
- Lifetime coverage
- Flexible premiums payments
- Cash value accumulation
- Tax deferral benefits
- Variety of investment strategies
Cons:
- Expensive premiums
- Cash value may be limited
- Careful monitoring is required
- Return on investment portion not always attractive
- Building cash value takes time
- Flexibility could require a health exam
How to get a term policy with Unity Financial Services
Pros of universal life insurance
- Lifetime coverage
Your universal life insurance policy, being a form of permanent insurance, will stay in force as long as you continue to pay your premiums.
- Flexible premium payments
Usually, you have the flexibility to make adjustments to the coverage amount and premium payments over time, adapting to changes in your life or income.
- Cash value accumulation
With each premium payment, a part of the funds is allocated to an account, representing the cash value of your policy, which has the potential to accumulate interest over time.
- Tax deferral benefits
Similar to many life insurance policies, the death benefit paid to your beneficiaries is typically tax-free. However, the interest earned on the cash value portion of your policy is tax-deferred, offering a potential advantage in your specific situation.
- Variety of investment strategies
There are different types of universal life insurance, and these options give you some flexibility in choosing how the investment portion of your policy is used
Cons of universal life insurance
- Premiums can be expensive
Universal life insurance is often not a cost-effective option for most individuals. It can be excessively expensive, posing challenges for policyholders to sustain payments and keep the policy in force.
Unity Financial Services term life insurance rates are among the most budget-friendly in Canada, and there’s a 10% discount for couples applying together in their first year.
- Cash value may be limited
Your insurer might limit your cash value returns or investment amounts based on tax laws. Therefore, it’s advisable to inquire about factors like the “participation rate” or contribution limits before finalizing your decision.
- Careful monitoring is required
There isn’t a hands-off version of these policies. It’s essential to keep a close eye on your policy, ensuring that you’re paying the correct premiums and preventing depletion of your cash value. Failure to do so could result in the loss of the policy.
- Return on investment portion not always attractive
While the concept of an investment portion may seem attractive, it’s advisable to scrutinize the potential interest rates. If your goal is to invest for your financial future, you may find better options with a traditional investment account, such as a TFSA or RRSP.
- Building cash value takes time
Cash value is a well-known feature of universal life insurance, but it requires time to accumulate. It’s advisable to have a clear understanding of the timeframe it will take before you can potentially withdraw or borrow against your life insurance in case of an emergency.
- Proposed flexibility could require a health exam, causing increased premiums
These policies are frequently marketed as flexible coverage that can be adjusted as your needs evolve. While this flexibility may seem advantageous, it’s important to note that increasing your coverage might necessitate a health exam, potentially leading to higher premiums.
Is universal life insurance a good investment strategy?
Guaranteed Universal Life Insurance (GUL)
Guaranteed universal life insurance provides a universal life policy with minimal to no cash value. It’s also referred to as “no lapse guarantee universal life insurance,” and the absence of cash value ensures that the policy won’t lapse due to insufficient cash value to cover premiums.
This type of insurance is often presented as a way to secure the lowest premium payment for universal life coverage. However, when the cash value is reduced to a minimum, the policy resembles more closely a whole life policy, making it a potentially better choice. Notably, by eliminating the cash value component, the policy becomes even more similar to a term life insurance policy.
If affordability is a priority and the cash value component is less crucial, considering term life insurance may be a more suitable option. Term life insurance offers coverage for the necessary duration at a price that fits your budget.
Example of Guaranteed Universal Life insurance in Canada: Manulife Security UL.
Types of universal life insurance in Canaada
There are a number of different types of universal life insurance policies. While they all offer lifelong coverage, there are differences in how they are structured.
Guaranteed Universal Life Insurance (GUL)
Guaranteed universal life insurance provides a universal life policy with minimal to no cash value, often referred to as “no lapse guarantee universal life insurance.” The absence of cash value ensures that policy lapsing due to insufficient funds to cover premiums is not a concern.
This type of insurance is sometimes presented as a means to secure the lowest premium payment for universal life coverage. However, when the cash value component is minimized, the policy more closely resembles a whole life policy, making it potentially a better choice.
Furthermore, by eliminating the cash value component, this policy becomes even more similar to a term life insurance policy. If affordability is a top priority over the cash value component, exploring term life insurance might be a more suitable option. Term life insurance provides coverage for the necessary duration at a cost that aligns with your budget.
A Canadian example of Guaranteed Universal Life insurance is Manulife Security UL.
Note
These types of universal life insurance often have proprietary names, so you may need to do some research to make sure you know exactly what kind of policy you’re looking into
Indexed Universal Life Insurance (IUL)
In a universal life insurance policy, your cash value may be allocated to various investment options, including:
1. A fixed-rate investment account with lower risk.
2. An account linked to the performance of an index, presenting higher risk.
Note: The availability of indexed universal life insurance in Canada depends on the insurer’s investment options. If index funds are offered, it results in an indexed universal life insurance policy. However, various other investment options such as stocks, equities, and bonds may also be available.
It’s crucial to be aware that fees and costs associated with indexed universal life insurance policies can be substantial, encompassing insurance premiums, administrative fees, and investment management fees. These fees have the potential to erode returns and impact the overall performance of the policy.
Additionally, returns on the investment component might be subject to caps, limiting full participation in the gains of the underlying index.
An example of Indexed Universal Life insurance in Canada is RBC Universal Life™ Insurance.
Variable Universal Life Insurance (VUL)
Variable universal life insurance operates similarly to an indexed universal life insurance policy, where the cash value is invested. However, in this case, the investments are akin to mutual funds. Policyholders can decide the allocation in each fund, adjusting based on the funds’ historical performance.
Just like mutual funds, each investment fund carries associated management fees. It’s crucial to carefully examine these fees to ensure they do not significantly diminish potential returns.
Compared to other universal policies, variable universal life insurance policies typically have higher fees and are more intricate. Individuals who prefer an active role in selecting investment options for their policy’s cash value may find these policies attractive. However, those seeking a more hands-off approach or who are risk-averse might want to steer clear of VUL.
Whole vs. universal life insurance in Canada
Universal life insurance and whole life insurance are both forms of permanent insurance coverage, but they vary in terms of cost and flexibility.To illustrate, consider each type of insurance as a bucket designed to hold your money.
Whole life insurance is the safer option
In this insurance type, you pay a fixed premium, and the contents of your hypothetical bucket remain constant. The funds in your bucket accumulate, with a portion allocated to insurance premiums and another part invested.
This is perceived as the more secure option, as your funds typically go into a low-risk fund, alleviating concerns. In fact, your insurer guarantees a rate of return.
Our suggestion: If you anticipate not actively managing the policy to ensure consistent payments over time, a universal policy may not be the ideal choice. A whole life policy would likely better align with your needs.
Universal life insurance has more flexibility
In universal life insurance, the amount in the metaphorical bucket can vary. Why? The cost of insurance may increase, depleting your accumulated funds.
Additionally, if the investments within the bucket perform poorly, you may be required to pay higher premiums. Inability to meet the required amount could lead to the lapse of your policy.
With universal life insurance, you also have the flexibility to choose where your funds are invested. Moreover, you can decide whether to pay your premiums on a monthly or annual basis.
Our advice: If you desire the ability to make decisions regarding the investment component of your policy and appreciate flexibility, a universal policy may be the suitable choice.
Whole vs. universal life insurance cost
Whole life insurance entails a consistent monthly cost that remains unchanged over time, providing stability. Although it may be more expensive upfront, it offers a predictable and steady financial commitment.
Conversely, universal life insurance may begin with a more affordable premium but tends to become more expensive as you age. The flexibility in premium payments and potential investment returns can contribute to the changing cost structure over time.
Universal life insurance in Canada vs. term life insurance
Although both are prevalent life insurance options, they differ significantly in their mechanisms and associated costs.
Universal life insurance: invest or avoid?
Universal life insurance is a form of permanent life insurance that includes components like cash value, investment features, and tax-deferral benefits. While these elements suggest a more comprehensive coverage, it’s important to note that their actual benefits may vary.
Premiums for universal policies are typically higher, posing a potential challenge for individuals striving to manage long-term payment commitments.
Term life insurance: the smarter alternative
Term life insurance provides coverage for a designated duration, such as the period when you have dependents like children or elderly parents. Opting for a 10 or 20-year term ensures protection during this relevant period.
As your needs diminish over time, your coverage can be adjusted accordingly. It’s uncommon for individuals to maintain constant coverage needs throughout their entire lifetimes.
For instance, you might only require coverage during the period of raising a family or taking care of elderly parents. Subsequently, as the term concludes and your responsibilities for dependents diminish, you have the option to let your term insurance policy lapse.
You don’t have to find yourself without coverage at the conclusion of your term. Many term life insurance providers offer both renewable and convertible policies. This means you can extend your term coverage if necessary or convert your policy to a permanent one in the future.
Term life insurance is significantly more budget-friendly, allowing you to potentially choose a higher death benefit while maintaining affordable premiums.
Consider comparing the costs of term life and universal life insurance to discern the distinctions.
In summary: don’t ignore the potential pitfalls of universal life insurance
Universal life insurance offers certain advantages but is also marked by complexity, which can pose challenges.
Evaluating the value of the various components contributing to the premium costs can be intricate. Additionally, the policy demands vigilant monitoring, often beyond the expertise and time available to most individuals.
For many Canadians, a term life insurance policy combined with external savings and investment accounts may be a more beneficial and straightforward choice.
Unity Financial Services simplifies the process of obtaining term life insurance. Get a quote, apply online, and discover your approval status in 20 minutes or less.
Laura McKay
COO & Co-Founder
Laura McKay, the co-founder and COO of Unity Financial Services, has played a significant role in the growth of Canada’s leading digital life insurance company. Recognized as one of the Women of the Year by Bay Street Bull in 2021, Laura holds a Bachelor of Mathematics from the University of Waterloo, with a focus on Actuarial Science. Her academic background equipped her with expertise in mortality risk, the fundamental basis of life insurance pricing and valuation.
Laura’s professional journey includes valuable experience with industry giants such as Manulife and Munich Re, where she contributed to Actuarial Science. Subsequently, she joined Oliver Wyman, a renowned management consulting firm in New York, from 2013 to 2018. In this role, Laura collaborated with Fortune 500 life insurance companies, aiding them in developing growth strategies while addressing operational challenges and regulatory issues.
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Read MoreFAQ: Universal life insurance in Canada
Before making any decisions, it’s crucial to conduct a thorough review of your policy and coverage. Schedule a call with an advisor who can provide insights into the meaning of the numbers and the history of your policy.
Gather information on the premiums paid and the accumulated cash value, and request an updated projection of future numbers. Keep in mind that guarantees are typically not assured, so your decisions will be based on historical data and the best projections available.
Additionally, explore the consequences of canceling your policy. This may involve potential tax implications or policy fees that need to be considered.
If you cease paying premiums on your universal life insurance policy, several outcomes may occur:
Initially, premiums might be covered from the policy’s cash value to maintain its active status. This is contingent on there being sufficient cash value in the policy to cover the premiums.
While this approach can temporarily sustain your coverage if you face challenges paying premiums, it comes with a caveat. If the cash value is depleted entirely by using it to pay premiums, you risk losing your coverage.
Alternatively, you have the option to cancel your policy if you no longer wish to pay premiums. In this case, you’ll receive the cash surrender value, representing the remaining cash value in the account. Keep in mind that surrendering the policy usually incurs surrender charges, acting as a penalty for cancellation. Additionally, any amount received is subject to income tax in the year of cancellation.