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Universal and Variable Life Insurance: Know the Risks

Financial advisors often promote universal life insurance and variable universal life insurance policies because of their potential for cash value growth based on market performance. Coupled with the insured’s ability to borrow against the cash value of the policy and the tax-deferment benefits of making additional deposits, these life insurance policies often appear to be a wise investment.

But without a good understanding of the potential risks, they can also threaten your financial investment. Sure, this kind of insurance policy covers you throughout your lifetime. However, when you consider how much money you pay for the policy over the long-term, you could achieve a greater return via other investment tools.

Universal life insurance and variable universal life insurance function in similar ways. Buyers get an insurance policy plus a cash value account that’s funded by your premium minus the cost of your insurance and any administrative fees charged by the company. The money in your cash value account is pooled with others’ into a general investment account made up of various securities which can increase or decrease in value according to stock market activity.

These are high-commission products that are being marketed and sold for investment purposes instead of insurance purposes, which makes them appealing to investors who are seeking a reliable growth opportunity for their money while also protecting their families after their death. However, the drawbacks can outweigh the benefits:

Universal Life and Variable Life Insurance Policies Are Expensive to Hold

Premiums and fees are very high, especially compared to what’s typically required to manage mutual funds alone and what you might earn as interest on your investment. Policies commonly require account management fees that are several times the operating costs, making them more expensive than just investing in a mutual fund.

Premiums Increase While Benefits Do Not

With universal policies, the premiums increase regularly, if not yearly, while coverage remains unchanged. The result is paying more but not getting more.

It’s Hard to Keep Your Cash Value Above the Cost

The cash value of the policy must overcome the cost of the premiums for this to be an effective investment tool. The cash value is reliant on stock market performance and continued policyholder funding to grow. As long as the premium increases at a faster pace than the value of the cash account increases, the policyholder loses out.

Policy Performance Is Tied to Market Performance

With a variable universal life insurance policy, the variable interest can make premium payments go up and down unpredictably; interest rates shift based on the market and are vulnerable to instability. This can make it a challenge to budget investment costs and require a significant increase in premiums to maintain coverage.

Flexibility Comes at a Cost

While these policies let the insured choose to skip or underpay a premium, it cuts into the investment account. Do this too often, and the investment account can suffer.

A Withdrawal Is Really Just a Loan

Brokers tell clients that the accrued cash value of these policies can be withdrawn as income at a later date, and while that is technically true, what actually happens is the withdrawal functions as a loan that needs to be repaid or it can decrease the final payout to beneficiaries of the policy.

The Backing of Your Account Can Evaporate

It’s important to realize that these life insurance policies are funded by a cash value account that’s dependent on stock market performance. Even though the cash value account is invested in a mix of securities, if the stock market falls dramatically, the cash value account will be negatively impacted and the illustrated returns will not come to fruition.  The investor will be left with a very expensive death benefit but a bad investment vehicle.

Universal life and variable life insurance policies are complex securities products that offer a life insurance benefit, although they’re typically marketed as the reverse. For unsophisticated investors who cannot monitor and recalibrate premiums and cash account investment decisions regularly over a lifetime, what seems like a safe investment can quickly turn into a financial drain.

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