Earlier this week, a reader from CA asked, “Which is better; Universal Life or Term Life?”
In my industry, that is a loaded question. Insurance agents are almost as polarized on that question as ordinary Americans are about abortion.
Those of us agents who were practicing during the late 1980s and early 1990s may not be the best people to ask.
We saw, less than professional, agents selling both Term and Universal life insurance incorrectly. However, the opinion of this “Old Fart” insurance agent was asked. I have never been shy about sharing my opinion, but I must stress, it is only an opinion.
When this question was asked, I remembered that I have addressed that issue before. However, when I looked, I found out that my comments about Universal Life (U.L.) were made over a year ago in an article I wrote, “Universal Life: Never Again.” I don’t expect someone to review over a year’s worth of posts to find out what I said about something in October, 2012.
Below you can read my response to her. As you do, please remember that this advice is only one strategy for using Life insurance for simple estate plans. More complex issues may require different types of insurance.
That is an excellent question. I have a very strong opinion about not using Universal Life insurance, however, I am forced to admit that I am biased against that type of insurance. I saw it used for purposes that it was never intended back in the 1980s. I also saw the resultant law-suits in the 1990s. You can read more about by biases in an article I wrote in October, 2012, “Universal Life: Never Again.”
I have been assured that the industry has made corrections to that type of product to make certain it is not abused again. However, I am just not comfortable with it, for two reasons.
I. Many insurance agents claim that it can be used to fund a child’s education or retirement. That is true. It can. However, it can only do those things under certain circumstances because of internal charges and fees. If your child is two years of age, or younger, the Universal Life makes a fine college fund. Make certain that you get a plan with a Disability Waiver that will pay your full “modal premium” while you are disabled and unable to work and not just the cost of insurance. That way, your child will have enough money for college, if you planned right, whether you live, die or become disabled.
Also, if you are using it to fund college for a child, make certain that you get a plan with a high enough death benefit. Modified Endowment Contract, (MEC), laws were created because too many Americans were using UL to hide money from the IRS. You will probably need a plan with much more death benefit than you want for a U.L. to do what you want.
II. Many insurance agents claim that U.L. makes a great supplement for retirement. It does. However, remember that it is only a supplement. There are other vehicles that you can use to save for retirement that will present a greater return on your investment.
The counter argument that an insurance agent can make is that if you use U.L. to save for retirement, the money is sheltered from taxes. That is true, provided the policy eventually ends by paying a death benefit. If you lapse (stop paying premium) or cancel the policy in your senior years, agents often fail to mention that all the money you have taken from the policy, above what you have paid in, is taxable income in the year your policy lapses.
The bottom line is, unless you are willing to commit to pay $200, or more, for life insurance for the rest of your life, it is doubtful that U.L. is what you need.
I prefer to use “Combination Plans.” That strategy requires you to purchase both Whole Life and Term Life.
The Whole Life policy, is only to pay for final expenses, like funerals, final medical expenses, small charitable bequests, probate fees, etc. You probably only need $10,000 – $25,000 of that type of insurance. My reasoning behind this type of insurance is that it provides Permanent coverage. It does not matter whether you die in 45 days or 45 years, it will be there.
HINT: Here is a hint for you. If you are going to us Whole Life insurance, look for a type of Whole Life insurance called, “Participating Whole Life.” While non-participating plans tend to pay stock-holders any profits, participating plans return excess earnings in the form of dividends. Those dividends can be used in future years to lower the amount of premium you must pay until such time as the dividend is greater than your premium. When that happens, you no longer have to pay premiums out of your personal cash flow but still have the life insurance during your senior years.
Everything, other than Permanent Life insurance needs, has an expiration date. The most common example is that children eventually grow up and are no longer financially dependent. (Other needs are to repay a mortgage, pay off credit cards or other loan, etc.) All of those things have two things in common.
- The amount of cash necessary is finite and can be calculated.
- All of those “needs” diminish over a period of time to the point where they no longer exist.
My advice, if your goal is to buy insurance to make certain those bills are paid if you die, is to spend enough money to buy satisfactory Term Life insurance. As you pay off debt, or children get older, the amount of life insurance required gets less. Every 3-5 years, do some shopping or decrease the amount of insurance you are paying for.
In my opinion, the only time that U.L. is justified is when U.L. is the only type of plan available for doing what needs to be done, like Second-to-die plans for estate or trust purposes or if it is the only type of plan that offers riders that you need, like Long Term Care insurance riders and you want it for the LTC protection as much as for the life insurance.
As I said before, I am aware that this is only an opinion. There are many good insurance agents who know how to use U.L. plans properly. My strategy is just one of several.
Just remember, when it comes to insurance, any strategy is good as long as you are able to accomplish what you want for what you consider is a fair price.
HINT: Just be wary if someone says to you, “Some insurance is better than none.” That may be true, but often it is a sign that the insurance agent, with whom you are working, will get more in commission if he sells you a U.L. with a lower death benefit than a Term plan that will provide all the protection you need.