Sell them what you want, not what they need.
Unfortunately, this happens A LOT in our industry.
Shady financial advisers will sell mutual funds, annuities, REITs, cash value life insurance — basically anything that might make more sense for them (in the form of making a commission) instead of the client.
This seems to be the case in almost every universal life insurance situation I’ve ever come across.
It’s often touted as a “great investment,” offering things like tax-free money just like a Roth IRA, a guarantee of principal, and on and on and on.
If you’ve been a reader of the blog, you’ll know I’m a firm believer that in the right situation, a financial product could work, but just like I see annuities being used inappropriately, the same applies to universal life insurance types.
A recent prospective client encounter illustrates that too perfectly.
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Universal Life Insurance Used Wrong
Both husband and wife are currently in their early 40s, and they don’t have a lot of savings.
The husband had a good government job, but was forced to resign, and is currently working part-time. They have little to nothing saved in retirement, and much of their past savings had been depleted helping out an ill family member.
Seven years prior, their insurance agent sold them a $1 million term policy (that I totally support), and a $100,000 universal life policy (that I totally do not support).
I asked the clients why they took out the universal life policy, to begin with, and their response was that the husband wanted something that would take care of his wife if something happened to him.
The term policy works perfectly for this. The universal life also does this but is MUCH more expensive.
He was paying $101 a month for the universal life policy and $88 a month for the 20-year term policy. If making sure that his wife was taken care of was his goal in taking out both policies, then in my opinion, the advisor fell short. The client could have purchased a much larger term policy and used the difference to start funding their retirement. The agent was trying to sell this policy as an investment for later.
Here’s where it gets even worse.
Diving into the numbers: the client took out the policy in October of 2007 and has been paying $101 ever since. At the end of last month, May 2014, the client had put in a total of $7,949 into the policy.
The total cash value accumulated was $6,000, with a surrender value of $5,900.
How’s that for an investment?
I’m not saying that universal life insurance is a horrible investment, but more times than none, it’s oversold to somebody who doesn’t need it. The husband and wife were not contributing to any retirement plans or IRAs when they took out the policy, which is something that should have been asked by the advisor.
Instead of putting money into an expensive universal life policy, they should have been funding a 401k or a Roth IRA.
If you’re considering buying a universal life insurance policy, here are the rules you need to follow:
Pros and Cons of a Universal Life Insurance
Pros of Universal Life Insurance
1. Flexible Premiums: One of the standout features of universal life insurance is the flexibility it offers in terms of premium payments. Policyholders have the option to adjust their premiums and death benefits, which can be particularly beneficial if their financial situation changes over time.
2. Cash Value Component: Universal life insurance policies come with a cash value component that earns interest over time. The interest rate is usually pegged to the market rate, meaning it has the potential to grow significantly.
3. Potential for Earnings: The cash value of a universal life insurance policy can be invested, offering the potential for additional earnings. This investment component can help policyholders grow their wealth while also providing life insurance coverage.
4. Tax Advantages: The cash value component of a universal life insurance policy grows on a tax-deferred basis. Additionally, beneficiaries typically receive the death benefit free of income tax.
5. Permanent Coverage: As long as premiums are paid, universal life insurance provides permanent coverage, ensuring that beneficiaries are supported financially after the policyholder’s death.
Cons of Universal Life Insurance
1. Complexity: Universal life insurance policies can be complex and may be difficult for the average person to fully understand. The various features and options available require careful consideration and potentially the assistance of a financial advisor.
2. Higher Premiums: Compared to term life insurance, universal life insurance premiums are typically higher, especially in the early years of the policy. This can make it a less affordable option for some individuals.
3. Interest Rate Risk: The cash value component’s growth is subject to interest rate fluctuations. If the market performs poorly, the cash value may not grow as expected, potentially impacting the policy’s performance.
4. Potential for Lapse: If the cash value drops too low and is not sufficient to cover the cost of insurance, the policy could lapse, leaving the policyholder without coverage.
5. Fees and Charges: Universal life insurance policies often come with a range of fees and charges, including administrative fees, mortality charges, and surrender charges if the policy is canceled early. These costs can add up over time, reducing the policy’s value.
Rules for Universal Life Insurance
Have an Insurance Need
I once encountered a situation where a 26-year-old female, a 26-year-old single female, was sold a $1 million universal life policy. The insurance agent pitched it to her as a guaranteed savings account that was offering somewhere in the 6% to 7% range. She was told that she could never lose her principal and that she’d be making a great return on her money.
It turns out what she really had was a $1 million universal life insurance policy. She was paying a good chunk per month toward it, and when there happened to be a botch in how she was paying for her quarterly premium, it prompted her to investigate what exactly she had, because, in the short term that she’d had it, she hadn’t seen this 6% interest that the agent had spoken of.
After contacting the agent’s home office, she learned the truth. She had been sold a $1 million universal life insurance policy. When she learned that, her immediate question was, why does a 26-year-old woman who’s not married, with no kids, who has $100,000 of student loan debt, need a $1 million life insurance policy?
Of course, the back office couldn’t answer that question and deferred that to her agent. There’s no question that she did not have an insurance need, and therefore had no need for a universal life policy.
Have Term Insurance
It irks me to no end when an adviser or life insurance agent sells universal life insurance as an investment that also has protection. If they are leading in with that, and they haven’t even had the discussion of term life insurance, they are immediately added to my list of financial advisors I’d like to punch in the face. Term life insurance is dirt cheap, and that is where you need to start before purchasing any type of universal life policy.
To put things in comparison, I purchased a $2.5 million term life insurance policy for $2,500 per year as an annual premium. When I started inquiring about a universal life policy for myself, here is what I found.
Keep in mind in my own personal situation, I am unable to put into a Roth IRA because of the income limit. I was looking at a universal life policy as a long-term savings tool as well. (note: the policy I was reviewing was an indexed universal life policy).
If I structured the universal life policy to where I would pay $10,000 per year of premium and did so for 10 years, that would give me a death benefit of $285,743. The policy offers the ability to accumulate cash value, but the guaranteed rate is 3% before expenses.
By the time I was 60, I could pull a whopping $104,000.65 guaranteed. There are some ties to the market where the value could be much more. If I were to average 5.5%, that total would be $249,365, but as you can see, to have a $285,000 death benefit would take me putting in $10,000 a year for 10 years, which far exceeds the premium outlay for a term life insurance policy.
Roth IRA and/or 401(k) Is a Must
If the person pitching you universal life insurance policies uses the phrase “It’s an investment like a Roth IRA,” then why in the heck are they not suggesting you open a Roth IRA first? A Roth IRA should give you more bang for your buck, and won’t have the high cost of insurance attached to it. The same goes for a 401(k).
Preferably, I would love to see somebody maxing out both the 401(k) and a Roth IRA before they even explore any type of universal life policy. If the person is pitching you universal life insurance and they haven’t even inquired about whether you are putting money into your retirement account or not, you know they are sketchy. Move on quickly.
Compare the Cost of Multiple Carriers
In the original case above, where the individual is paying $101 per month for a $100,000 universal life policy, I was able to compare rates and see if they could even pay less than what they’re paying, in case they wanted to keep it.
It turns out I found multiple carriers that were far less than the $101 per month they were paying, from the top life insurance companies in the United States. The best option I found was actually $40 a month cheaper than what they were paying, for a total savings of just under $500 per year.
If you are fully committed to taking on a universal life policy, make sure the person selling it to you has the ability to work with multiple carriers. If they are working for a big box company that can only offer one solution, then you better at least get a quote from somebody else.
Smart Insurance Choices: Navigating Life Policies and Investments
|Universal Life Insurance Pitfalls
|Caution! A 26-Year-Old was Sold a $1 Million Universal Life Policy With False Promises. Verify Before Committing
|Term Life Insurance First
|Start with Term Life! It’s Cost-Effective Protection Without Unnecessary Complexities
|Cost Comparison: Term vs. Universal
|Crunch the Numbers! $2.5 Million Term Policy vs. $285,743 Universal After 10 Years
|Roth IRA and 401(k) Priority
|Secure Your Future! Max Out Roth IRA and 401(k) Before Considering Universal Life for Better Returns
|Skepticism Alert: Check Multiple Carriers
|Be Savvy! Compare Carriers; a $101/Month Policy Could be $40/Month Cheaper Elsewhere. Choose Wisely
The Bottom Line
The short answer is no. Universal life insurance is not a ripoff, but it had better make sense for what you’re trying to accomplish. For example, I’ve seen these types of policies used for estate planning purposes to pass more on to the heirs of clients. In these cases, universal life insurance makes A LOT of sense.
For the couple that was sold a universal life policy above, I suggested they contact their agent and find out why exactly they were sold the policy in the first place.