A universal life policy covers both the insurance and investment needs of individuals who may benefit from it most. The universal life policy includes a term insurance policy that is attached to a tax sheltered investment account. The Income Tax Act legislates that the investment account that accompanies the insurance is tax sheltered. As such, the policy’s beneficiary is not required to pay taxes on the growth of the funds within the investment account. Accordingly, a universal life policy can serve as an excellent estate-planning tool because it can provide a large lump-sum payment. This lump-sum payment can then assist beneficiaries in paying for the capital gains taxes that arise upon the death of a taxpayer.
Universal life policyholders are required to pay an annual amount that will partially cover the costs of the annual insurance premium. The balance, which is determined by the policyholder’s cash flow, will serve as the investment portion. Expenses and administration fees are then deducted from the investment portion. In Canada, tax legislation determines the maximum amount that policyholders can add to their plans. The maximum amount depends on an actuarial calculation that is related to the amount of insurance coverage as well as the policyholder’s age.
The most suitable investor for a universal life policy is someone who has contributed the maximum to his or her RRSP and also has investments outside of their retirement account. Generally speaking, income on investments outside an RRSP is subject tax and this income is eligible to become sheltered within a Universal life policy.
Another benefit of universal life policy is its inherent flexibility with respects to deposits and withdrawals. Universal life policies provide the ability for policyholder’s annual deposits to be the minimum amount required to keep the insurance in force, the actuarial maximum, or any amount in between. Additionally, the policyholder is allowed to withdraw funds at any given time. Despite this fact however, when the funds are withdrawn, the taxes become payable.
As an example, business owners have the option to include surplus cash in their plans when their business is doing well. Whenever their cash flow is limited, or their equipment must be purchased or facilities renovated, business owners have the option to withdraw the necessary funds leaving just enough money in the plan to cover the insurance premiums. As a recap, universal life policies are generally considered best suited for those who have maximized RRSP and pension contributions, as well as eliminated or largely reduced non-deductible interest debt.
It is advised that you consult with a financial advisor if you are considering the purchase of a Universal life policy.
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