Traditional universal life insurance is one of the most misunderstood products in the insurance world. Every day, JRC Insurance Group receives calls from distraught and frustrated clients who have discovered that their universal life insurance has essentially imploded, leaving them with the difficult decision of either forking out thousands of dollars to keep their policy or forfeiting their coverage.
Worse yet, there is often no decision to be made. Few middle-aged people working toward retirement on a fixed income have a comfortable $5,000, $10,000 or whatever the sum, lying around to pay to their life insurance company out of nowhere. So, they are forced to let their life insurance policy lapse and risk not being able to qualify for a new policy.
These horror stories happen quite frequently, but how?
Quick Article Guide:
1. The “Non-Guaranteed” in Non-Guaranteed Universal Life Insurance
2. The Fine Print Behind “Cash Accumulation”
3. Assumptive vs. Guaranteed Interest Rates
4. How Cash Value Goes Down to Zero
5. Universal Life Insurance’s Heyday Has Long Passed
6. Better Alternatives
Universal life insurance, also referred to as “UL,” offers flexible premiums and a death benefit (money paid to the beneficiary after the insured’s death). Universal life insurance splits into two main categories: guaranteed universal life insurance, and non-guaranteed universal life insurance. Many agents sell non-guaranteed policies because they come with a tax-deferred investment opportunity called “cash value” or “cash accumulation.”
With non-guaranteed universal life insurance, the insured pays the premium of their life insurance as well as some additional money to “overfund the policy” and build cash value. Theoretically, the cash value gains interest over the long haul, allowing the policy to pay for itself out of the cash accumulation account, while the insured continues to build cash value.
Sounds great, right? One problem: that word, “non-guaranteed.” It’s subtle on paper but stark in real life. There is no guarantee that your cash accumulation will perform favorably, and if it doesn’t, your universal life insurance policy can eat away at your cash value until there is nothing left. At that point, the insurance company sends you a notice to either replenish or relinquish your policy.
In 2012, The Wall Street Journal published an article titled, “Draining Away,” explaining how millions of Americans will be affected by the exact scenario we’re describing. We’ll revisit their piece shortly.
Many people misinterpret cash accumulation to be an extra savings source that they can access freely or leave to their family. That’s how most savings investments work but not cash value in life insurance. Here’s what you need to know about each potential scenario involving your cash value.
If You Borrow
Agents will tell you that you can borrow from your cash value to fund your retirement, pay for your children’s college education, etc. They’re not wrong, but they’re downplaying the word, “borrow.”
Understand that if you withdraw the cash value in your policy, you’re taking out a loan from the life insurance company. You will be charged a “cash surrender” fee of up to $750 dollars, and will have to pay interest on the money you have withdrawn until the loan is paid back. It pretty much works the same as a bank loan or credit card, and some insurance companies charge interest rates near 10 percent.
If You Don’t Repay
Let’s say you die before you are able to repay the loan. The amount you borrowed would be subtracted from your death benefit, essentially leaving your family with less money than expected. If you tell your heirs that they will receive $150k from your life insurance policy after you die, but then you borrow $50k from your cash accumulation and die before you are able to pay the money back, your family will receive $100k—an unpleasant surprise in an already upsetting situation.
If You Save
At this point, you’re probably thinking, “Okay, I’ll just save the cash value so my family receives it after I die.” Unfortunately, it doesn’t work like that, either. Cash value is not an additional death benefit. If you die before you withdraw the cash value in your policy, your insurance company keeps the money. So, in actuality, cash value in life insurance is never really yours in any form.
Universal life insurance policies offer an assumptive rate of interest, and a guaranteed rate of interest that is based on the current market conditions. Both of these rates are disclosed in your policy’s paperwork, however, insurance agents rarely focus on the interest rate that is actually guaranteed. When reviewing your policy, it’s important to note that the “assumptive” interest rates are a completely hypothetical illustration of how well your policy may perform in ideal market conditions.
Ironically, the only thing “assumptive” about an assumptive interest rate is usually that it will not come to fruition. The vast majority of traditional universal life insurance policies do not earn more than the interest rate guaranteed by the insurance company. Naturally, someone trying to sell you a policy is going to ride the assumptive rates, so it’s important to know and plan based off of the guaranteed rate. Some purchasers of universal life insurance policies have actually sued the insurance companies for being misled by their agents!
In an article titled, “Retirees Stung by ‘Universal Life’ Cost,” The Wall Street Journal explains that insurance companies are not liable for any assumptive rates of return your agent may have suggested. When pressed about this confusion, universal life insurance companies point to the disclosed minimum guaranteed rate.
Traditional universal life insurance policies adjust the cost of insurance (COI) each year. As you age, your COI increases to account for your increased mortality risk. This means your policy needs a growing surplus of money to account for the increased cost.
Unless the policy’s investment value performs well (which is rare these days), the cash value will slowly but surely dwindle until the insured loses their coverage—usually sometime in their 60s or 70s.
One of the worst horror stories we’ve seen is that of an older man who had bought a policy through an agent many years back. His cash accumulation dried up completely before he became aware of what was happening. To retain his life insurance, he was required to pay the cost of his policy, plus the mortality risk charge, plus his base premium—all out of pocket and with no warning. To make matters worse, he had a major health issue and simply could no longer qualify for new life insurance. At a time when life insurance was more important than ever, the man had no means of protecting his family from potential financial hardship after he dies outside of a “final expense” policy to cover burial costs.
Fees on Top of Fees
Even if your investment does do well, the many fees associated with universal life insurance can make a dent in your cash value. These include any combination of annual investment fees, management investment fees, administrative fees, and money management fees. The terminology varies, but it all means little to no return on your universal life insurance policy. And when you couple the fees with the rising COI, you have a recipe for a disaster like the example we just gave.
When universal life insurance was first introduced to the market in 1978, Treasury yields were at the brink of an all-time high. In fact, by 1982, the 10-year Treasury yields were hovering at 15 percent. The 1980s marked the heyday of universal life insurance. Double-digit growth seemed like a sure thing for anyone investing money into a universal life insurance policy.
Fast-forward to 2016, and the owners of these policies must continue to pay additional money into their universal life insurance policies to prevent their coverage from lapsing.
WSJ’s “Draining Away” piece explains:
“The problem for people holding such policies now is that many agents said in their sales pitches that interest on the cash account could subsidize rising insurance costs as policyholders aged. That let policyholders pay a smaller premium than they would have paid on a whole-life policy.
Since then, though, interest rates have plunged. In the late 1990s, many universal-life accounts paid interest rates of 7% to 8% a year, says Jeremy Kisner, a certified financial planner at SureVest Capital Management in Phoenix. Now that rates are at multi-decade lows, the savings portions of old policies are rising much more slowly than the agents suggested…
… If rates don’t rise soon, policyholders will have to cough up more money to cover fees—typically 20 to 60 days after the savings balance runs dry.”
Whether you are considering buying your first life insurance policy, or shopping for a new policy to replace your traditional universal life insurance, JRC recommends keeping your investments and your life insurance separate.
An article recently published on Forbes compared a real-life example of funding a 401(k) versus purchasing a universal life insurance policy. The client had an option of purchasing a traditional universal life insurance policy at an annual rate of $8,700, or purchasing a 30-year term life policy for $700 a year and investing the difference into a 401(k).
The universal life insurance policy and 401(k) both assumed a growth rate of 8 percent. It is also important to note that in the current market, a universal life insurance policy rarely yields a rate higher than 3 percent, because the current Treasury rates are less than 2 percent. Nonetheless, we assume the traditional universal life insurance policy performed at an annual rate of 8 percent, so in 30 years, the client could expect to have a cash value of approximately $600,000.
Using the same scenario listed above, if the client purchased the 30-year term policy and invested the difference into a 401(k), the approximate cash value (assuming the same rate of growth of 8 percent), would have been $980,000. That’s 39 percent more money for retirement expenses. Even if you dramatically lower the interest rates for the 401(k) and the universal life insurance policy, the 401(k) is always the better option.
If you’re set on the need for permanent coverage, guaranteed universal life insurance (GUL) is usually the way to go. GUL functions like a term life policy, with a set death benefit and set premiums, except you choose which age you want the policy to last to rather than a set number of years.
GUL policies are available well into a person’s 90s or even 100s. And, the best part about GUL is that there is no investment component, so you get the permanent coverage you need, without the market risk. See a side-by-side comparison between guaranteed vs. non-guaranteed universal life insurance here.
Regardless of what type of life insurance you are looking to purchase, be sure to work with an independent agency like JRC. Unlike captive agents at big-box companies, we can shop the entire market to find you the best coverage at the best rates. We’re owner-operated, nationally licensed, and committed to finding each and every client the right insurance for his or her needs. Call us today at 855-247-9555, or request a free life insurance quote online using the button below.
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