Welcome to Part 10! Today we are going to explore why someone would consider "over funding" a Universal Life Insurance policy. If you would like to skip back one article, click here to go to Part 9.  If you would like to start at he beginning of this series (highly recommended if you haven’t read it before!) then click here to go to Part 1.

Remember from the last article that a Universal Life insurance policy is like a Whole Life insurance policy in that there is an insurance component AND an investment component.  Whereas with Whole Life the goal of the investment component is to lower the cost of insurance over the course of one’s lifetime by taking the over-payments early on and investing them – eventually growing them enough to pay for the "underpayment" later on, with Universal life the policy holder has the ability to adjust the amount of the overpayment, and also direct the actual investment allocation of the investment account.  There are numerous reasons and strategies for this flexibility.

Also remember that I said you could structure a Universal Life policy to behave like any other life insurance product.  If you wanted, you could not make ANY over-payments over the pure cost of insurance, and in effect be paying for Term Life insurance.  However, since there are additional administration costs in setting up a Universal Life insurance policy, this effectively becomes the most expensive way of setting up a Term Life insurance policy.

You could also set it up to behave just like a Whole Life policy by making the necessary overpayment and using a predominantly fixed income allocated investment portfolio.  In this case, you will have the investment account build up over time, and eventually this investment account would fund the "underpayment" years – just like a run of the mill Whole Life policy.

Of course, if either of the above scenarios were your goal – you would simply choose the Term Life or the Whole Life and save a few percentage points with a reduced administrative charge – since those policies are more cut and dried and less complex to setup.

Where the advantages of Universal Life come from, are the following:

1) Adjust the investment selection.  If you think you can outperform the insurance company’s normal investment selection, then you could build up the investment side account more quickly.  This would allow you to reduce the overall cost of your insurance, or increase your coverage.  If your aim was to have the dividends eventually pay for the cost of the policy itself, this would happen sooner with a better rate of return of the investment account. You can also modify the investment selection on an ongoing basis.

2) Adjust the payment.  UL (Universal Life) will allow for you to change how much money you pay each year into the policy. That means you can pay a lot one year, and then nothing the next if you so desired.  The insurance company will let you know what the minimum payment required is to keep the policy in effect, so if you paid a large overpayment one year, you may or may not have a minimum payment the following year.  The cost to keep the basic policy in tact will be deducted from the investment side account.  A popular strategy is to grossly over fund the payment as much as allowable (especially in the early years) so that investment side account grows to as large an amount as possible in the tax sheltered environment.

The main reason someone would over fund a UL policy would be to access the funds inside the investment side account at some point in the future.  If someone was maximizing the amount of money put into the normal tax sheltered environments (i.e. RRSPs in Canada), then funnelling money into a UL policy through over-payments will provide another tax sheltered haven!  They would do this to allow for their savings to grow faster, and over time the differences can be huge.  Even though they will have a tax bill when they pull the money out at some point in the future, the amount of extra growth can more than offset the extra tax.

In Part 11, we are going to look at an advanced UL strategy that is commonly used by individuals that will allow for an almost tax free retirement using what we’ve learned so far! Stay tuned, because in my opinion a strategy like the one in Part 11 is one of the only reasons you would use Universal Life insurance!

CLICK HERE TO GO TO PART 11 

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