Universal Life Insurance – Part 2
So, do we NEED universal life insurance? The main life insurance need most people have is income replacement. If you have anyone that is financially dependent on you (your family) and you want to know they will be okay if you die, you probably need to have some life insurance to replace that part of your income that they would need to be okay.
The need for income replacement goes away with time, though. When you retire (we call it being “financially independent”), you can live fine without working. By then, your kids are usually adults and are no longer dependent on you. Your spouse will get your investments and much of your pension, so most people have little or no income replacement need once they retire.
What life insurance do you need after that? Here is where an insurance salesperson often needs to “create” a need. The main needs usually used are taxes on your estate and avoiding probate fees.
If your estate is mostly illiquid assets that your kids will want to keep, such as a cottage, then taxes on your estate are a problem. You give your kids the cottage, but your estate first needs to pay the capital gains tax, which can be a lot. If you have no investments, then they can only pay it by selling the cottage.
For most people, however, your main assets are your RRSP’s and your house (which your kids won’t keep). So your estate has lots of cash. If your estate is $1 million and there will be $200,000 tax when you die, all that means is your kids get $800,000 instead of $1 million. Is this worth paying life insurance premiums all your life for?
Paying probate fees take some effort to be made to seem important. They can be $10,000 (on a $1 million estate)! Wow! But when you look at the numbers, you can see through it. Probate fees are between .5% and 1.5% of the assets passed by the will. Since the insurance policy names a beneficiary, the death benefit passes outside the will, so you avoid the probate fees.
However, life insurance premiums for minimum universal life are usually at least 1% of the death benefit each year. Getting 10 or 20-year term is only about 1/3 the cost. So, if you live for 2 years, you have probably already wasted more in excess premiums than your estate will one day save in probate fees.
In short, most of our clients are in their 30’s, 40’s and 50’s. Do they need insurance for life? Who knows? They usually need income replacement insurance now and to build wealth for retirement. But there is nothing that tells us they will need life insurance after they are “financially independent”. This is probably true for at least 95% of the population.
If you don’t have a need for insurance for life, then universal life insurance is a waste of money. And if you do, only buy it if it is cheaper than term 100.
The other question relates to the investments. Universal life allows you to pay extra into the policy to invest. Is investing in a universal life insurance policy a good idea?
The “need” created is usually tax deferred growth, avoiding income tax on your estate (again) and avoiding probate fees (again). However, you can get the same tax deferred growth by buying corporate class mutual funds. And the other 2 are rarely worth paying the premiums all your life.
There are some major disadvantages of investing in a UL policy:
1. You are restricted to the investments within that policy, usually all from that one insurance company.
2. Most of the investments are “segregated funds”, which are insurance mutual funds that charge .5-1% higher MER’s each year.
3. There is a 2% premium tax on the extra premium you pay in to buy the investments.
In short, you can virtually always invest much better outside of your insurance policy.
So, if hardly anyone has a need for insurance for life and if investing outside of your insurance policy is almost always better, why are so many universal life policies sold? For most insurance salespeople, every problem looks like a nail.
Of course, universal life and whole life insurance products pay many times higher commissions than regular term. It is not easy to make good money selling life insurance if all you do is term (which is all most people need). This is why they need presentations on how to “create a need”.
In short, “Buy term and invest the difference” is wise advice for almost everyone. Get renewal and convertible term, so you can convert it to a term for life IF you one day actually need it.