Universal life insurance
Higher than expected payments could be required if the policyholder has skipped payments or has been paying less than originally planned. The more guarantees a policy has, the more expensive its cost.If there is more than one assignee, the assignee are paid in the based on date of the assignment. If the policyholder skips payments or is late for payments, it is possible that this will need to made up for in later years by making larger than expected payments.
No Lapse guarantees can also be lost when loans or withdrawals are taken against the cash values. There are two other areas that differentiate Universal Life from Whole Life Insurance.
If the loan interest is not paid, it will be deducted from the cash values of the policy. Fixed Premium UL is paid for by periodic premium payments associated with a no lapse guarantee in the policy.
The no lapse guarantee is a safety net that provides for coverage in the event that the cash value isn t large enough to cover the charges. If the experience of the plan is not as good as predicted, the account value at the end of the premium period may not be adequate to continue the policy as originally written.
. Also a range of premium payments can be made to the policy, from a minimum amount to cover various guarantees the policy may offer to the maximum amount allowed by IRS rules.
In a UL the policy will lapse (the death benefit will no longer be in force) if the cash value or premium payments are not enough to cover the cost of insurance. Sometimes the cost associated with the guarantee will still be deducted even if the guarantee itself is lost.
The policy remains in force so long as the COI charges have not depleted the account. And with UL, many of guarantees are tied to an expected premium stream.
(this assumes the policy is not a MEC) Withdrawals are considered a material change and cause the policy to be tested for MEC. These policies were very popular prior to 1988, as life insurance is generally a tax deferred plan, and so interest earned in the policy was not taxable as long as it remained in the policy.
If the premium is not paid on time, the guaranteed may be lost and cannot be reinstated. Also the death benefit of life insurance policies generally does not face income tax as long as the policy was not received as a result of payment by you to the previous owner of the policy.
That is, the policy is established with the insurer where premium payments above the cost of insurance are credited to the cash value. It s flexible premiums include a risk that the policyholder may need to pay a greater than planned premium in order to maintain the policy.
VUL s allow the cash value to be directed to a number of separate accounts that operate like mutual funds and can be invested in stock or bond investments with greater risk and potential reward. Sometimes the guarantees are part of the base policy and sometimes the guarantee is an additional rider to the policy.
Taking Loans on UL will affect the long term viability of the plan. Further withdrawals from the policy were taken out principal first, rather than gain first and so tax free withdrawals of at least some portion of the value were an option.
Universal Life is a type of permanent life insurance based on a cash value. This can happen if the expected interest paid on the accumulated values is less than originally assumed at purchase.
Some policies provide an option for reinstating the guarantee within certain time frames and/or with additional premiums (usually catching up the deficit of premiums and an associated interest). This will shorten the life of the policy.
The death benefit coverage is paid for by mortality charges (also called cost of insurance). The IRS defines the method of testing whether a life insurance policy is a MEC.
(those fees are often built into the cost of insurance and the costs will not adjust when the guarantee is lost). This happened to many policyholders who purchased their policies in the mid 1980 s when interest rates were very high.
In 1988 changes were made in the tax code, and single premium policies purchased after were Modified Endowment Contract (MEC) and subject to less advantageous tax treatment. In order to remain active, the policy must have sufficient available cash value to pay for the cost of insurance.
If a collateral assignment is placed on life insurance the assignee will receive any amount due to them before the beneficiary is paid. (as opposed to the death benefit which is provides benefit to the beneficiary.) These benefits include loans, withdrawals, collateral assignments, split dollar agreements, pension funding, and tax planning. Most Universal Life Policies come with an option to take a loan on certain values associated with the policy.
(usually this is a change in death benefit or risk) It is important to note that a MEC is determined by total premiums paid in a 7 year period, and not by single payment. Some policies do not allow anymore than the one premium contractually, and some policies are casually defined as single premium because only one premium was intended to be paid.
The cash values removed by loan are no longer earning the interest expected, so the cash values will not grow as expected. If there is not sufficient value in the policy to cover interest, the policy will lapse. Loans are not reported to any credit agency and payment or non payment against them will not affect the policyholders credit rating.
As a result of a withdrawal, the policy may become a MEC and cause lose its tax advantages. ie - The earlier assignment date gets paid before the later assignment date. A Single Premium UL is paid for by a single, substantial, initial payment.
If the policy is held until death, the cash value will escape taxation entirely. The primary difference is that the universal life policy shifts some of the risk for maintaining the death benefit to the insured.
But it can also be permanent fixed payment for the life of policy. Universal life is more flexible than whole life in two primary ways: the death benefit and usually the premium payment are flexible.
Since the base policy is inherently based on cash value, the fixed premium policy only works if it is tied to a guarantee. The cash values removed by loan are no longer earning the interest expected, so the cash values will not grow as expected.
Usually those loans will cause a greater than expected premium payment as well as interest payments. Outstanding loans will be deducted from the death benefit at the death of the insured. An illustration showing the effect of a loan is recommended in order to assess the outcome of this change. Most Universal Life Policies come with an option to withdrawal cash values rather than take a loan. However if the policy lapses while the growth has been withdrawn, there may be substantial income tax owed. Universal Life is used as a tax-advantaged way to purchase life insurance.
As long as the policy has not become a MEC (Modified Endowment Contract) it will not have a tax deferred status. At any point in the life of a policy, a premium or a material change to the policy could cause it to lose its tax advantage and become a MEC. In a MEC, the premiums and accumulation will be taxed just like an annuity upon withdrawing, the accumulations will grow tax deferred and will still transfer tax free to the beneficiary under Internal Revenue Service Code 101a under certain circumstances.
These type of contracts only participate in the movement of Index and not the actual purchase of stocks, bonds or mutual funds. This guarantee will be lost if the policyholder does not make the premium as agreed, although the coverage itself may still be in force.
In the early years of the contract, the premium far exceeds the cost of insurance (COI) charges. If any form of loan is taken on the policy, this may cause the policyholder to pay a greater than expected premium, because the loaned values are no longer in the policy to earn for the policyholder.
Withdrawals will permanently lower the death benefit of the contract at the time of the withdrawal. Withdrawals are taken out premiums first and then gains, so it is possible to take a tax free withdrawal from the values of the policy. This also makes it an alternative for individuals who are not able to contribute to a Roth IRA due to IRS income restraints. Interest Rate Risk: UL is a complex policy with risk to the policyholder.
Generally these payments will be for a shorter period of time than the policy is in force; for example payments may be made for 10 years, with the intention that thereafter the policy is paid-up. Any gain in the policy will remain non-taxable unless withdrawn.
In a whole life policy, as long as every premium payment is made, the death benefit is guaranteed to be paid if the insured dies. If the policy has not become a Modified Endowment, the loans are withdrawn from the policy values as premium first and then any gain.
The death benefit can be increased (subject to insurability) and decreased without surrendering the policy or getting a new one as would be required with whole life. The cash value is credited each month with interest, and the policy is debited each month by a cost of insurance (COI) charge, and any other policy charges and fees which are drawn from the cash value if no premium payment is made that month.
The interest credited to the account is determined by the insurer; sometimes it is pegged to a financial index such as a bond or other interest rate index. A similar type of policy that was developed from universal life policies is the variable universal life insurance policy, or VUL. Policies purchased previous to the change in code are not subject to the new tax law unless they have a material change in the policy.
Withdrawing values will effect the long term viability of the plan. The withdrawals are subject to contingent deferred sales charges and may also have additional fees defined by the contract.
It is important to distinguish between this no lapse guarantee and the actual death benefit coverage. Typically each year the starting point is last year s ending point which means that: (1) the policy amount is locked in at the end of the year; and, (2)the beginning value from which the movement measured is reset. Universal life is similar in some ways to, and was developed from whole life insurance.
As long as these charges can be deducted from the cash value, the death benefit is active. An illustration showing the effect of a withdrawal is recommended in order to assess the outcome of this change. Collateral Assignments will often be placed on life insurance to guarantee the loan upon the death of debtor.
They may have a cap (but not always) as to the maximum amount they will credit interest to and a minimum guarantee which keeps the principal of the contract from losing money in a down year. And if the guarantee is lost, the planned premium may no longer be sufficient to keep the coverage active.
This is because the premiums are paid with after-tax money, so the money going in has already been taxed, and only growth would be taxed. The Insurer charges interest on the loan because they are no longer able to receive any investment benefit from the money that has been loaned to you. Repayment of the loan principal is not required, but payment of the loan interest is required.
These loans require interest payments, which are paid to the Insurance Company. As the interest rates lowered, the policy did not earn as expected and the policyholder was forced to pay more to maintain the policy.
The potential advantage of the universal life policy is in its flexibility and the potential for greater cash value growth if the interest rates offered outperform the insurer s general account (that whole life policy cash value growth is based on). To some extent this issue is mitigated by the corresponding lower death benefit.
Some policies do not provide for the possibility of reinstating this guarantee. Inherently UL policies are flexible premium, but each variation in payment has a long term effect that must be considered.
If the guarantee is lost, the policy reverts to it flexible premium status. The first is that the expenses, charges and cost of insurance within a Universal Life contract are transparently disclosed to the insured, whereas a Whole Life Insurance policy has traditionally hidden this type of information from the policyholder.
No Lapse Guarantees or Death Benefit Gurantees: A well informed policyholder should understand that the flexibility of the policy is tied irrevocably to risk to the policyholder. Many people use Life Insurance, and in particular cash value Life Insurance as a source of benefit to the owner of the policy.
In this case, the policyholder may have the choice to either: Many universal life contracts taken out in the high interest periods of the 1970s and 1980s faced this situation and lapsed when the premiums paid were not enough to cover the cost of insurance. Flexible Premium UL allows the policyholder to vary their premiums within certain limits. Additionally, there is the recent addition of Equity Indexed Universal Life contracts analogous to Equity Indexed Annuities that invest in Index Options on the movement of an Index such as the S&P 500, Russell 2000, and the Dow (to name a few).
Secondly, there are more flexible provisions within a Universal Life contract including zero interest or wash loans which in limited cases can provide the policyholder the ability to access the growth inside the contract without paying income tax. For example, some policies will offer a no lapse guarantee, which states that if a stated premium is paid in a timely manner, the coverage will remain in force, even if there is not sufficient cash value to cover the mortality expenses.
To make their policies more attractive insurers often add guarantees, where if certain premium payments are made for a given period, the policy will remain in force for the guarantee period even if the cash value drops to zero. The difference between the two (the cash value ) will grow tax-deferred so long as the policy remains in force.
It is recommended that yearly illustrative projections be requested from insurer so that future payments and outcomes can be planned. In addition, Flexible Premium UL may offer a number of different death benefit options, which typically include at least the following: Policyholders may also buy Flexible Premium UL with a large initial deposit, thereafter making payments irregularly. In the US it is illegal to offer Universal Life Insurance as an investment, but it is frequently offered by agents as a tax-advantaged financial vehicle from which they can borrow as needed later without tax penalties.
