Universal life insurance (UL) in Canada is a complex permanent life insurance product combining lifetime coverage with flexible premiums, adjustable death benefits, cash value reserves, and investment components. Read on to understand how they work, pros and cons, costs, alternatives, and tips for Canadians considering these plans.
What is Universal Life (UL) Insurance?
Universal life insurance falls under the permanent life insurance umbrella, offering lifelong coverage for whole life insurance. However, these policies include unique features that set them apart. Universal life insurance combines a death benefit with a cash value account, allowing flexibility in premium payments and potential adjustability of the death benefit amount.
Some key attributes include:
| Feature | Description |
|---|---|
| Lifelong coverage | As long as adequate premiums are paid, universal life provides lifelong protection. |
| Flexible premiums | Payments can be scaled up or down within limits set by the policy terms. |
| Cash value account | An interest-earning account that premiums fund can be borrowed against or withdrawn from. |
| Adjustable death benefit | The death benefit may be negotiable, depending on your policy. |
How Does Universal Life Insurance Work in Canada?
Universal life insurance provides permanent coverage while offering flexibility and investment components, but how do these policies function? Understanding how UL policies work helps to break them down into two central elements: the cost of insurance and cash value.
- Cost of Insurance (COI): The minimum premium required to keep the death benefit active. It covers the insurer’s mortality charges, fees, expenses, and administrative costs. As the insured ages, the cost of insurance increases.
- Cash Value: Any premium payments above the COI get deposited into a cash value account. This reserve earns interest based on current rates or a minimum guaranteed rate, whichever is higher. These funds grow tax-deferred, and if the cash value grows large enough, withdrawals may cover the COI charges.
Premiums Paying
Policyholders can adjust their premium payments up or down within certain limits, providing financial flexibility. Typically, the policy outlines a minimum and maximum annual limit. If you pay only the minimum, the cash value will grow more slowly. Paying higher premiums builds cash value faster. As long as the insurance cost is covered, the policy remains active.
Withdrawing Cash Value
Policyholders can access their cash value through withdrawals or policy loans for emergencies, supplemental retirement income, or other financial needs. However, this reduces the death benefit paid to beneficiaries. In addition, inadequate funds could result in a lapse if the insurance premium isn’t paid.
Lapses and Defaults
If the cash value falls too low and can no longer cover the monthly insurance charges, the policy may default and lapse. Maintaining adequate premiums and cash value prevents policy termination.
Adjusting Coverage
Some policies allow the death benefit amount to be increased or decreased within certain limits as insurance needs change. This requires approval by the insurer.
In summary, the premium flexibility, adjustable coverage, tax-deferred cash value growth, and lifetime coverage offered by universal life insurance in Canada provide advantages over traditional permanent life insurance. An insurance advisor can help navigate the intricacies.
Pros and Cons of Universal Life Insurance: A Balanced View
| Key Benefits | Potential Drawbacks |
|---|---|
| Lifelong Protection: Coverage lasts your entire life, not just for a set term, as long as the policy is funded. | Complexity: Policy illustrations can be hard to understand, with non-guaranteed projections and complex fees. |
| Premium Flexibility: You can increase, decrease, or even skip premium payments (within limits) based on your cash flow. | Lapse Risk: If the cash value is depleted and can’t cover the rising insurance costs, the policy could terminate unexpectedly. |
| Tax-Deferred Growth: The cash value account grows without being subject to annual taxes, allowing for faster compounding. | Non-Guaranteed Returns: Unlike Whole Life, cash value growth is not guaranteed and depends on investment performance, which can be volatile. |
| Access to Cash: You can borrow against or withdraw from the cash value for emergencies, retirement, or other needs. | Rising Internal Costs: The underlying Cost of Insurance (COI) increases as you age, which can drain the cash value more quickly in later years. |
| Adjustable Death Benefit: Allows you to increase or decrease your coverage amount as your life circumstances change (subject to approval). | Cash Value Retention: In many standard policies, the insurer keeps the cash value upon death; only the face amount is paid to beneficiaries. |
Types of Universal Life Insurance in Canada
Canadian insurers offer several types of UL policies. The primary difference is how the cash value account is invested.
Standard Universal Life
The standard universal life policy offers a guaranteed death benefit, a cash value account, and flexible premium payments. The cash value earns interest at rates declared by the insurer.
Standard universal life provides straightforward permanent coverage with premium adjustability and cash value control. It’s the most common and straightforward form.
Indexed Universal Life
Indexed universal life links cash value growth to a market index like the S&P 500. This allows for potential growth based on positive index performance while providing downside protection from losses in many policies.
It carries some market risk but offers the possibility of more robust cash value growth than standard universal life over the long term. The death benefit and premium flexibility remain.
Variable Universal Life
Variable universal life allows policyholders to invest their cash value in separate subaccounts, including stocks, bonds, and mutual funds. Returns depend on the performance of your investment holdings.
The ability to choose different asset classes provides greater potential rewards and increases investment risks compared to other types. Experienced investors can benefit from the management and diversification options.
Universal Life with Secondary Guarantees
Some insurers add secondary guarantee provisions on universal life policies, promising that the policy will remain in effect for a defined period (e.g. 20 years), even with zero cash value, as long as scheduled premiums are paid.
This safety net gives peace of mind that the policy won’t lapse prematurely due to declines in cash value driven by market conditions. It protects against unexpected early termination of coverage.
Canadians should understand the different types of universal life insurance available to determine which aligns best with their budget, risk tolerance, and insurance needs.
What Does Universal Life Insurance Cost in Canada?
Universal life insurance rates can vary substantially based on your age, gender, smoking or high-risk hobbies, lifestyle, health condition, and desired coverage amount. The following are some sample costs:
- $1,410 annually for a 42-year-old non-smoking female with $150,000 coverage.
- $3,991 annually for a 38-year-old non-smoking male with $500,000 coverage.
- $5,324 annually for a 55-year-old non-smoking male with $300,000 coverage.
These premiums represent the minimum payments required to sustain the policies. Additional funds could be added to build the cash value.
To determine your specific rate, licensed advisors can provide personalized quotes comparing options from Canada’s top insurers for universal life insurance.
Comparing Universal Life Insurance to Alternatives
While UL offers lifelong coverage plus unique features, it has potential limitations. Here are two alternatives to consider.
Universal Life vs. Term Life Insurance
If coverage is only needed for the short term, term life insurance provides lower-cost temporary protection. It can complement permanent policies or be used independently.
Universal Life vs. Whole Life Insurance
For permanent protection, whole life policies offer guaranteed cash value growth and death benefits with fixed lifetime premiums. However, whole life insurance is typically more costly than universal.
Comparing Universal life vs Whole life vs Term life insurance
| Feature | Term Life Insurance | Whole Life Insurance | Universal Life Insurance |
|---|---|---|---|
| Coverage Period | Temporary (10, 20, 30 years) | Permanent (Lifetime) | Permanent (Lifetime) |
| Premiums | Lowest cost, fixed for the term | Highest cost, fixed for life | Flexible (within limits) |
| Cash Value | None | Yes, guaranteed growth | Yes, non-guaranteed growth |
| Guarantees | Death benefit guaranteed for term | Death benefit, cash value, and premiums are fully guaranteed | Only the death benefit is guaranteed (if funded); cash value is not |
| Best For | Temporary needs (mortgage, income replacement for young families) | Guaranteed estate liquidity, predictable costs | Tax-sheltered growth, flexibility, business/estate planning |
Decision Making: Choosing Between Whole Life and Universal Life Insurance
The decision between Whole Life and Universal Life insurance is not about which product is superior. Carefully weighing your budget, risk tolerance, and timeline can help determine which product better suits your needs.
To illustrate this, let’s examine the case study below:
Michael (age 40) is an entrepreneur and small business owner with fluctuating income.
Financial Personality: Moderate risk tolerance. Michael is comfortable with a degree of uncertainty in exchange for flexibility and the potential for higher returns. He is actively involved in his finances.
Primary goal:
- Provide a death benefit to protect his family and potentially fund a business buy-sell agreement, with the ability to adjust the coverage amount as his needs change.
- Build cash value but wants the flexibility to pay more in profitable years and less during leaner times.
For Michael, Universal Life (UL) insurance is the superior option. The flexibility of Universal Life is the primary reason it fits Michael’s situation.
As Michael’s income is not consistent, he can overfund his policy during good business years, allowing the cash value to grow more quickly. During a slow period, he can pay a lower premium, or even skip a payment, and let the policy’s accumulated cash value cover the monthly costs. This adaptability is crucial for someone with a variable income.
Universal Life also allows him to apply to increase the death benefit (subject to medical underwriting). Conversely, if his needs decrease in retirement, he can reduce the coverage to lower his policy costs.
In addition, Standard Universal Life policies credit interest based on current market rates (subject to a minimum guarantee). This means there is potential for the cash value to grow faster than the fixed rate offered by a Whole Life policy, especially in a rising interest rate environment. This aligns with Michael’s moderate risk tolerance and desire for better returns.
Thus, Universal Life offers Michael the adaptability in premiums and death benefits that his entrepreneurial life demands. The trade-off for this flexibility is a need for more active management and an acceptance of non-guaranteed returns, which Michael is willing and able to handle.
Tips for Purchasing and Managing a UL Policy in Canada
If universal life insurance aligns well with your situation, here are helpful tips for purchasing and managing your policy:
- Consult an experienced advisor to navigate the intricacies.
- Closely examine all fees that could impact your cash value.
- Opt for conservative investment vehicles within your cash value to minimize risk.
- Avoid withdrawals in early policy years when surrender charges may apply.
- Monitor your cash value account regularly to avert a potential lapse.
- Discuss premium payment options in case you experience financial constraints.
- Notify your insurer before any adjustments in premiums or death benefit amounts.
- Review your policy at each renewal period and adjust details as needed.
The Bottom Line: Should You Consider UL Insurance?
Universal Life is a sophisticated financial instrument, not a simple insurance product. For the right person, typically a high-income earner, business owner, or someone with significant estate planning needs, it offers unparalleled advantages for tax-efficient growth and wealth transfer.
For most Canadians simply seeking death benefit protection, Term Life or Whole Life insurance is often a more suitable and straightforward option. The key is to work with a qualified, credentialed advisor who can model your specific situation and help you determine if UL aligns with your long-term financial objectives.
FAQs About Universal Life Insurance in Canada
Does universal life insurance expire?
No, it is permanent insurance designed to last your entire life, provided the policy is sufficiently funded to cover the internal costs.
Are the premium payments for universal life insurance tax-deductible in Canada?
Generally, no. An exception is when a UL policy is used as collateral for a business loan, where a portion of the premiums may be deductible. Consult a tax professional for specifics.
How is a policy loan taxed in Canada?
Policy loans are not taxed when you take them. However, if the loan amount exceeds the policy’s ACB and the policy is surrendered or lapses, the gain becomes taxable.
What can I use the cash value of a universal life insurance policy for?
You can use it for emergencies, supplemental retirement income, education costs, starting a business, taking time off work, or anything else you may need funds for.
Do I need an advisor to get a universal life insurance policy?
An advisor can help navigate complexity, but isn’t required. You can get quotes and purchase policies directly from insurers.
Article Sources
To ensure the accuracy and authority of this guide, we reference information from leading industry and government bodies.