The Income Tax Act stipulates that the growth of an “exempt” life insurance policy reserve is
tax-deferred until cashed-in by the policyowner. If the life insured dies before the policy is
cancelled, the death benefits are paid tax-free to the beneficiary. That is, the deferred tax is
Universal life was designed to permit policyowners to take full advantage of the deferred
taxation provisions of the Income Tax Act.
A universal life insurance policy consists of three basic elements:
an investment account
the cost of administration
Universal life has unbundled these elements. In other words, each of the elements is priced
separately and can be changed without directly impacting the other factors. For example, it
is possible for the policyowner to increase the amount of insurance coverage (thereby
increasing the mortality costs within the policy) without causing a corresponding increase in
premium deposits. Similarly, the policyowner could withdraw some of the cash from the
policy without having to cancel the policy or pay interest on a loan.
When a premium is paid, the money goes into an investment account where it earns income.
The cost of life insurance (mortality costs) and administration are taken from the investment
account. This mechanism is important because it allows untaxed (tax-deferred) investment
income to be used to pay for the cost of insurance and administration.
Consequently, the cost of insurance in a universal life policy can be as little as half of the cost
of permanent insurance, which is paid for with after-tax dollars. The premium paid for
universal life can be flexible, provided that enough money remains in the investment
account to fund the mortality costs and administration.
Unlike traditional plans, where the policy account value is invested in a portfolio by the
insurance company investment managers, universal life offers the policyowner the option to
choose the weighting of investments within the account from a wide range of options,
guaranteed term deposits
funds that track specific market indices (linked accounts)
segregated funds and mutual funds
What are the Advantages and Disadvantages of Universal Life?
UL takes maximum advantage of preferential tax treatment of life insurance policies.
The insured can build a significant investment portfolio that includes tax-deferred income.
Tax-deferred investments can be totally or partially withdrawn at any time.
At death the total value of the investment account will be paid tax free to the beneficiary,
in addition to the life insurance benefit.
The mortality charges and administration costs will be paid from untaxed investment
income. The insured accepts the risks that future investment returns may be inadequate to
fund the cost of insurance.
The insured accepts the risks that future investment returns may be inadequate to fund
the cost of insurance.
Policies that are funded with the minimum required premium are expensive relative to
term-100 policies because of the extra administration costs.