Universal life insurance is a trap for reckless retirees

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Universal life (UL) policies became popular decades ago when they were touted as being more flexible and modern than traditional life insurance policies. The problem is that they have characteristics that require the attention of policyholders as they approach the end of their life.

Another problem is that these policies have been sold as tax-efficient investment vehicles, ignoring the fact that they are still life insurance policies whose main function is to help your loved ones when you die.

First, let’s learn a bit more about UL policies and read a real-life example involving the potential pitfall. Next, let’s look at four possible strategies you can implement to protect yourself and your family from unpleasant surprises.

Universal life policies background

Although promoted as an investment vehicle, a UL policy is still life insurance: it pays a death benefit if you die while the policy is in force. However, unlike many traditional life insurance policies, the premiums you pay are not fixed. Each year you are allowed to pay a premium above the actual cost of insurance for the year. This excess amount accumulates as cash value and is credited with interest or investment income.

The good news is that any interest or investment income on the cash value you hold isn’t taxed while it accrues, which is why UL policies have been sold as a tax-efficient investment vehicle. Another tax advantage is that death benefits paid under the policy are not subject to income tax.

Depending on the terms of each UL policy, you may be able to withdraw the cash value at a later date and cancel the policy, if you decide not to continue the policy until your death. At that time, you will be taxed on interest or investment income on the amount of cash value that exceeds the premiums you have already paid.

Once you have accumulated cash value, you are allowed to pay a premium that is less than the actual cost of insurance for the year. In this case, to keep the UL policy in force, the insurance company takes the amount of the missing premium from your cash value to cover the full cost of insurance. If your cash value is reduced this way for several years, your cash value could drop to zero and the insurance company will void your policy. Unfortunately, this can be common for someone age 70 or older, as the annual cost of insurance increases dramatically with age.

A concrete example of the trap

The potential pitfall of UL fonts can be illustrated by a real-life example that recently came to my attention. A family friend took out a UL policy in his late 50s. The sales agent advised him to pay a premium each year that was well above the cost of insurance at the time the policy was sold. The policy accumulated cash value over several years, and all seemed well.

However, when the family friend turned 70, he acknowledged that he might not remember to pay the annual premium to keep the policy in force. So he implemented an auto-pay feature that automatically paid a fixed amount from his bank to cover the premiums to the insurance company.

However, the family friend did not realize that the cost of insurance could increase significantly and the amount of self-paid premium could then fall below the cost of insurance, which is exactly what that happened to him. Eventually his cash value dropped to zero and the insurance company canceled the policy.

The family friend died of COVID in the mid-1980s, after being quite frail for many years. Her son asked for the amount of insurance to help the surviving mother, and at that time he learned that the insurance company had terminated the policy.

The insurance company had repeatedly sent notices to the father, warning him of the impending cancellation. The problems were that the policyholder was too frail and distracted to pay attention to these notices, and that the sales agent who sold him the policy was long gone.

This reveals a potentially serious flaw in UL policies: these policies should be designed to recognize that policyholders may become frail or suffer from dementia towards the end of life, when they may not respond to posted notices. And neither the insurance company nor the insured can count on the presence of the commercial agent to intervene several years after the sale of the policy.

Four possible strategies to avoid unpleasant surprises

If you’re a UL policyholder and you’re approaching 70 or have reached 70, you might want to consider four possible steps to prevent unpleasant surprises from happening to you. and to your family.

First, notify your insurance company of a trusted contact who should be contacted if you stop responding to important notices. Many financial institutions and insurance companies are adding this feature due to their growing awareness of the issue of aging policyholders. You can often name a trusted contact easily by going online and updating your information.

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Note that your trusted contact can only notify you if you have received notices from the insurance company. They cannot act on your behalf unless you give them legal authority through a power of attorney.

Second, check to see if your policy offers a non-lapse guarantee. Such a policy would keep your policy in place if you have made a minimum level of premium payments, even if the cash value has fallen below zero. Ask your insurance company or agent if your policy has such a feature and document the conversation. If your policy has such a feature, an automatic payout policy could keep your policy in force.

Here is a third possible strategy: if you anticipate that there will be a time when you might be shaky and not pay attention to major financial accounts, you can convert your UL policy to a traditional insurance policy with a fixed premium amount. . This would allow you to keep the policy in force by automatically paying the premiums. Check with your insurance company, some allow you to take this step.

Finally, here’s a fourth possibility that presented itself to another 90-year-old family friend. The cash value of her UL policy was rapidly dropping to zero as she paid premiums below the cost of insurance. However, since she had read the notices from the insurance company, she was aware of the situation. She decided to let the policy expire, realizing that her adult children were financially independent and did not need the insurance. She communicated her decision to her adult children, so that there were no surprises after her death.

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The bottom line is, if you’re 70 or older and have a UL policy, you don’t want to leave your family with a nasty surprise after you leave. Design a plan for politics now that will last for the rest of your life, no matter what.

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