Universal Life

Q: What is a universal life insurance policy and what are the details of how it works?
–M. Gutierrez, via e-mail

A: Universal life insurance policies offer an investment element and a death benefit, while giving the policyholder the right to increase or decrease the amount of the investment element. The policy pays a death benefit to the beneficiary and provides a cash-value account, which earns tax-deferred interest at market rates. It also offers you the right to borrow against the cash portion of the account.

It is important to know that universal life policies are not for everyone. They are among the most expensive policies because of their investment component, and they carry the most severe penalties if you fail to pay the policy premiums. Michael Smith, a certified financial planner at ProFocus Inc. (www.profocus.com) in Phoenix, says universal life policies are best for “older persons or wealthy persons who have loads of discretionary income and have maxed out their 401(k) and other tax-deferred savings vehicles.” He cautions that although these policies are sold as “cash value savings vehicles,” the fees factored into your premiums can often offset any tax-deferred savings. And, if you dare cancel your policy prior to seven to 10 years, most policies have a “surrender charge” that will leave you with little or nothing of your accumulated cash value.

Universal life policies are best used to park large sums of money for 10 to 20 years until after retirement when you’re likely to move into a lower tax bracket — but you must be certain you can pay the hefty premiums over that extended period of time. People 45 years old and younger are probably better off buying $500,000 to $1 million worth of cheaper term life insurance and investing any money left over in some other tax-deferred savings vehicle.

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