Insurance: Beware Of Universal Life

Has a life insurance agent suggested that you buy 'permanent' insurance such as Whole Life, Universal Life or Variable Universal Life? The reasons they give seem so compelling, but are they in your best interest? Here's an explanation of the basics, plus what the insurance agent isn't telling you!

There are two broad categories of life insurance--term and permanent. The basic idea behind life insurance is that if you die prematurely, there will be a pot of money there to take care of your loved ones. That pot of money is referred to as the 'death benefit'.

The cost of life insurance is based on your age, your gender and your health. The insurance company bases the premium on the risk that you will die. The older you are or the poorer your health, the more expensive the insurance will be.

The 'raw' cost of insurance goes up every year because the risk of death increases every year. Term and permanent insurance approach the payment plan differently. With level term, these increases in cost are spread out over 10, 20 or 30 years and the premium is kept the same. If you renew your policy at the end of the term, your insurance costs will increase.

With permanent insurance, your premium stays the same as long as you own the insurance, up to age 100. That way, you shouldn't be in a situation where it becomes too expensive as you age. Initially you pay more than the raw cost of insurance and that money is kept in reserve. Once the raw cost of insurance is greater than your premium, the difference is taken from the reserve.

The difference between Whole Life, Universal Life and Variable Universal Life has to do with the return you earn on that money while it's kept in reserve. Whole and universal essentially pay interest while variable universal allows you to 'invest' that reserve in mutual-fund-like accounts.

On the surface, it may seem that there shouldn't be a lot of difference between the premium on 20-year term and a universal policy with the same death benefit. But let's look at some real numbers. The annual premium for a 45-year old man in excellent health for $1,000,000 in coverage is $1400 per year for 20-year term. That man would pay roughly $8,000 a year for permanent insurance. That's right--about $6600 more every year.

That reserve in the permanent insurance can become a substantial over time, so they give you the ability to borrow the money held in reserve. This has spawned the use of permanent insurance for needs other than the death benefit, such as a way to build a retirement nest egg. The 'ploy of the day' is that you should take all the equity out of your home and put it into a universal life insurance policy because it will allow you to build your wealth more quickly. (I expose the fallacy of that argument in a future article.)

What your insurance agent isn't going to tell you is that the commission on permanent insurance can be around 70% of the first year premium and then maybe 5% a year on additional premiums. Commissions on first year term premiums can be as high as 100%. In our example above, the agent will make about $5600 on permanent versus only $1400 on the term. This higher commission is a tremendous incentive for agents to sell permanent insurance instead of term.

The result is a huge conflict of interest between the needs of the client and the desires of the agent. I would like to think that every agent will always do what's in the client's best interest, but we know that's not the case. And most agents are convinced that term is a waste of money and that permanent life insurance is the better choice. I don't.

I believe that permanent life insurance should only be used in special situations, such as to cover estate taxes due at death. I do not think it should be used when you want to provide for your family in the event of a premature death. I don't think it should be used as a way to 'build wealth' or as a type of retirement plan. In my next article, I'll explain why.

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