Universal Life (UL) insurance has been trending on social media, often presented as a hidden secret to wealth accumulation. Some insurance agents, particularly those involved in multilevel marketing, may tout UL as the ultimate investment strategy.
Let me help you understand the reality: UL insurance is far more complicated than many make it sound.
Understanding the Complexities of UL Insurance
Universal Life insurance combines life insurance coverage with an investment component. The idea is that you pay premiums, and part of those premiums go towards your insurance coverage, while the rest is invested to grow tax-deferred. It sounds appealing, but it requires regular monitoring and strategic adjustments.
The Catch: The investments in UL policies are not guaranteed. If these investments underperform, your premiums may increase to keep the policy in force. Should performance continue to lag, you could find yourself facing premiums you can’t afford, causing your policy to lapse. The unsettling truth? About 88% of UL policies never pay out, largely because policyholders let them lapse.
UL Insurance vs. RRSPs: A Better Choice?
A common question in estate planning is whether to invest in UL insurance or a Registered Retirement Savings Plan (RRSP). Both offer tax-deferred growth, but the similarities end there. Here’s a clearer breakdown:
- RRSP Advantages:
- Tax Deductibility: RRSP contributions are tax-deductible, providing immediate tax relief.
- Investment Options: RRSPs offer a wide range of investment choices, from mutual funds and ETFs to individual stocks. You also have the freedom to change institutions or advisors.
- Cost Efficiency: Management fees are often lower, and you have more control over your investment costs.
- Flexibility: While withdrawals are taxable, they’re typically made during retirement, when your income (and tax rate) is lower.
- UL Insurance Drawbacks:
- High Costs: UL policies often come with expensive in-house investment options and management fees.
- Restricted Investment Choices: Your investments are usually limited to the options provided by the insurance company.
- Lack of Portability: Once you commit to a UL policy, you’re tied to that insurer. Transferring your policy or investments is not an option.
- Uncertain Tax Benefits: The much-advertised “tax-free withdrawals” are not guaranteed. There’s no guarantee from the insurance company, nor is there any protection from the Canada Revenue Agency (CRA) against potential tax law changes.
When UL Insurance Might Make Sense
While UL insurance isn’t ideal for everyone, there are specific scenarios where it can be beneficial:
- Young, High-Income Earners: If you’re young, earning a substantial income, and have maxed out your RRSP and TFSA contributions, a UL policy could be a way to shelter additional wealth for the long term. But you should be able to handle market risk and not need access to the invested capital for decades.
- Estate Planning for High-Net-Worth Individuals: High-income earners looking to leave a tax-free inheritance may benefit from UL insurance. It allows you to transfer wealth to your heirs in a tax-efficient manner.
- Business Owners: If you’re a high-income business owner, corporately owned UL insurance can have advantages. It can be a way to invest excess corporate earnings, reduce taxable income, and plan for a tax-efficient transfer of wealth.
Important Note: The primary purpose of UL insurance should be to provide life insurance coverage. If you don’t have a genuine need for insurance, don’t buy a UL policy purely as an investment.
Canadian Tax Rule Changes and UL Insurance
Changes to Canadian tax rules in 2017 reduced the tax-exempt benefits within life insurance policies, making UL insurance less attractive. These changes mean there’s less room for tax-sheltered investment growth, and the policies are now more restricted than they used to be.
Estate Planning Perspective: Where Should You Invest?
For most individuals, focusing on RRSPs or Tax-Free Savings Accounts (TFSAs) is a better strategy. RRSPs provide tax relief today and help grow your investments for retirement. TFSAs offer tax-free growth and the flexibility to access your money whenever you need it.
However, if your RRSP and TFSA are already maxed out and you’re looking for additional ways to shelter income or pass down wealth efficiently, UL insurance might have a role in your estate plan—but only under the right circumstances.
Final Thoughts
Universal Life insurance isn’t the magic investment solution it’s often made out to be. The high costs, limited investment options, and management complexities make it a poor fit for most people. If you’re exploring UL as an investment, consult with an estate planning expert to ensure it aligns with your financial and legacy goals. In most cases, maximizing RRSPs and TFSAs will yield better, more flexible returns.