In Part 9 we are going to look at how Universal Life Insurance came about and how it differs from Whole Life Insurance. If you would like to start at the beginning of this series on Insurance, click here to go to Part 1. If you would like to go back to the previous article, click here to go to Part 8.

One issue I haven’t mentioned is the tax treatment of the investment account inside the Whole Life Policy.  It is a TAX SHELTERED environment – which means whatever happens inside this account is protected from taxation so long as funds are not drawn out for other use.  Since the majority of investments in this investment side account are fixed income, they normally would be taxed on an ongoing basis, but since it is tax sheltered – there is no tax on the annual gains. A tax sheltered environment helps investments grow at a faster rate than in a taxable environment.

Now, if you were to pull money out of the policy for whatever reason – all bets are off and it triggers a taxable event.  It is very desirable to avoid a situation like this – so be careful if you have a whole life policy that has been in effect for a long time and are thinking of cancelling it – you will be hit with a tax bill for sure!  And it can be quite sizeable!

Another thing that policy holders of whole life policy were asking about was the nature of the investments inside these investment accounts.  They figured that if the insurance companies were a little bit more aggressive with their investment selections, then the investment accounts would grow more quickly and therefore be able to fund more of the cost of the policy – which ultimately would mean that the premiums would go down!  Of course, the insurance companies had to make sure that they could whether all types of market performance scenarios and a largely fixed income based portfolio was they best way to do this.  In other words, the insurance companies didn’t want to have to deal with investment accounts that didn’t grow enough to fund the policy underpayment in later years!

Well this fact and the nature of the tax sheltering of the investment accounts spawned a product that would address these concerns and desires: behold, Universal Life Insurance!  The term Universal came about because you can structure this type of insurance to behave like any other type of life insurance product out there if you know what you are doing.

One term that gets tossed around when talking about Universal Life is "unbundling".  This refers to the unbundling of the various components that make up Whole Life Insurance – i.e. the pure insurance component and the pure investment component.  A Universal Life Insurance policy holder has the ability to pick the investments that go into the investment account of the policy – in the hopes that they can grow it faster than the predominantly fixed income portfolio that the insurer would prefer to use.  The catch is that the policy holder and not the insurance company is now on the hook if the investment account does not grow fast enough to pay the premium shortfall later on – the policy holder will have to pay for the shortfall.

So in essence, the insurance company has granted the policy holder the ability to select the investments that go into the investment component in exchange for being responsible for the performance of it! Policy holders believed this to be fair and Universal Life became attractive – especially to those who had an insurance need and some market savvy.

BUT WAIT! Another unique feature is that you are able to "Over fund" this investment side account – meaning that you can pay more than just the premium for the whole life insurance policy, but can also add more money – all of which will go into the investment side account.  By putting more money into this account early on, it is possible to build up a sizeable investment account in only a few short years – which means more policy dividends!  There is a limit as to HOW MUCH you can over fund a policy, and it is generally 4 times the minimum required premium – governments enacted this rule because people were dumping everything they could into these policies since the investment side account are tax sheltered environments!

More on this and the strategies employed by Universal Life Policy Holders in Part 10!

CLICK HERE TO GO TO PART 10 

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