Area of Law: Investments and Securities
Answer # 263
What is a Universal Life Policy?Region: Ontario Answer # 263
Universal Life is a type of insurance policy which covers both the insurance and investment needs of individuals for whom it is best suited. It involves a term insurance policy attached to a tax sheltered investment account. Under a provision of the Income Tax Act, the investment account that goes with the insurance is tax sheltered, so that beneficiaries do not have to pay taxes on the growth of funds inside the account. Accordingly, this kind of policy can be an excellent estate planning tool in that it may provide for a large lump-sum to help beneficiaries settle up the capital gains taxes resulting from the death of a taxpayer.
Universal Life policyholders pay an annual amount, only part of which is for the annual insurance premium. The balance, the amount of which is determined by the policyholder’s cash flow, is the investment portion. Expenses and administration fees will be deducted from the investment portion. The maximum amount policyholders can add to the plan is defined by tax legislation, and depends on an actuarial calculation related to the amount of insurance coverage and the policyholder’s age.
The type of investor for whom a Universal Life Policy is most suitable is the one who has contributed the maximum to his or her RRSP, and who has investments outside the retirement account. Income on investments outside an RRSP is generally subject to tax, but can become tax sheltered inside a Universal Life policy.
Another feature of Universal Life policy is its flexibility in terms of deposits and withdrawals. Universal Life policies allow the policyholders’ annual deposit to be the minimum amount required to keep the insurance in force, the actuarial maximum, or any amount in between. Also, the policyholder can withdraw funds at any time. However, when funds are withdrawn, taxes are payable.
For example, business owners may put surplus cash in the plan when the business is thriving. In years the cash flow is down or equipment must be purchased or facilities renovated, they can withdraw the necessary funds leaving only enough in the plan to pay the insurance premiums. Once again, Universal Life is generally considered most suitable for those who have maximized RRSP and pension contributions, and eliminated or largely reduced non-deductible interest debt.
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