In the world of personal finance, a few pieces of advice are essentially universal: Save diligently for retirement. Create a budget and try to stick to it. Don't spend yourself into a giant debt pit using credit cards. In other areas, the right choices are far more situational -- for example, whether or not universal life insurance is a good investment for you.
In this segment from Motley Fool Answers, host Alison Southwick fields a question on the topic from listener Mike -- who has already purchased a policy, and now wonders if it might have been a mistake. To help her help him, she's recruited pair of special guests: senior analyst Jason Moser and Motley Fool Wealth Management's Ross Anderson.
A full transcript follows the video.
This video was recorded on Nov. 27, 2018.
Alison Southwick: The first question comes from Mike. "A few years ago I was promoted into a role that pays an annual bonus. Coincidentally it was around the same time I was reviewing life insurance plans with my agent. He sold us on a universal life plan. My bonus would cover the annual payment.
"As I have become more financially astute, partially thanks to all the Motley Fool podcasts and services, I am starting to second-guess my decision to buy into this plan. Let's get into the questions. Does your team have any balanced insight into why universal life plan policies are useful and where they are detrimental? Being in a middle-class income bracket, am I the right profile for a policy like this? What are the penalties of risk for opting out of the plan?"
Ross Anderson: There's a lot to unpack, here.
Southwick: Let's do it!
Anderson: And on the universal life or all permanent life insurance -- and I'll break that down in just a second -- there are extreme fans and extreme haters, so we are going to try to take a balanced approach, here.a
In the life insurance world you have two major categories. You've got term life, which is a short-term product. It is meant to cover you for a certain period of time. You're generally getting the lowest cost and the reason that you're getting the lowest cost is that it's likely that it never pays out. If you're a young person and you get a 20-year policy, we hope you don't need it. I hope you're flushing your money down the toilet. If you're using that policy, it means you're dead. Sorry! The purpose of that is really to protect for your loss of income or resources if something happens to you before you would expect it to.
Permanent life insurance is the second category. It is intended to last your whole life. There's three versions of it: whole life, universal life, and variable universal life. Let's put all of those in a category. Those plans are appropriate for somebody that needs life insurance to go on forever.
If it has to pay out and you need that life insurance, that's normally going to address something like an estate planning goal, or if you've got an estate tax issue, or if you just want to make sure that your family, for some giving purpose, has the resources and liquidity there. At the end of life, regardless of when that is, that's when a permanent life insurance product is appropriate.
The way they get sold a lot is on the benefit of tax-free withdrawals, because of the way they work. Let's say, Jason, your life insurance is going to cost you $50 a month for a term life policy. Instead of paying $50 a month, we're going to bill you $200 a month. We're going to take the extra $150, we're going to put it in an account, and it's going to grow. That's going to ultimately support that life insurance contract long term.
They sell it with these really bold claims like, "Well, you can borrow from that money and it's tax-free. You can take from that money and you're not going to have any other investments that can do that." What you're borrowing from is your own money. All loans are tax-free. If you borrow money for a house, as you make house payments going forward, you're not being taxed on that money. I always take a little bit of issue with that.
The real question, here, is do you need permanent life insurance, and if not, now that you have it, what do we do? Now, let's hope I didn't just lose everybody with that.
Here's the issues with it. If you surrender a policy early on, there's generally big penalties and fees. The reason is that they paid your insurance agent a commission when he sold it to you and those have to be repaid from somewhere. They're going to take that out of your money if you give up the policy early.
If you decide that you don't need the policy, here's what you can consider. No. 1, you can ask them for a policy modification. Let's say you took out a $250,000 policy. You might be able to lower it to $150,000 or $100,000 without penalty, make a lower premium payment, and start compressing that and maybe you get some term life to balance out how much total insurance you need.
The questions that you want to ask the agent if you're preparing for a review is first, what is my surrender fee and do I have one still? Second, what is the crediting rate? How fast is the cash accumulating in this policy? Third, could I reduce the payment if I lower how much insurance I need? And I think you really need to go back to the drawing board a little bit and decide, "Do I need life insurance that goes on forever or am I trying to protect my income for a short period of time?" That's the main thing that you're really trying to decide, here. And if you don't need permanent life insurance, there's a couple of ways that you could scale it back or ultimately get out of it over the next few years, hopefully without penalty.
Southwick: I didn't think that was boring at all!
Anderson: I have to be careful with the insurance answers, because I really geek out on how the policies are built and what they were supposed to do. It could be the perfect policy and the perfect tool for a situation. The problem is they get sold wrong a lot, and they get sold to people that don't necessarily need all of those features. Hopefully Mike isn't in that situation and he has a use for it, but if not, getting out of it needs to be strategic.