Over-funding Universal Life Policy - Part 1

What would happen if you decided to over-fund your universal life policy?

What would happen if you decided to over-fund your universal life policy by putting in an extra $10,000 for investment purposes? Before making this decision, you need to look at whether or not the policy is a good investment alternative. What does it cost to get the money into the policy? Does the deposit increase any back­end loads? How would you get the money out if you needed it?

You know what interest your policy account is earning, and so you can calculate or ask what interest you may expect from the extra investment for the year. The interest earned on the money within the contract is considered inside buildup and is not subject to current income taxation. Make your decision based upon the alternative investments available at the time. Where else could you put those funds to provide higher net after-tax earnings with comparable liquidity and safety? Keep in mind that the company uses some of the return you earn to pay for your life insurance, so unless you need the insurance coverage, unwarranted expenses are reducing your returns.

Universal life is not without downside risk. It now has been used throughout an entire business cycle. It came into existence at a time when interest rates were at an all-time high. At first, even some of the agents selling it did not understand it, and in some cases, it was improperly sold. Some policy owners who purchased contracts in 1979 have insurance company illustrations for periods of 20 to 50 years based on 12 percent or more interest rate assumptions for the entire period. Often those who bought these contracts did not even realize that part of that return would be used up by expense and mortality charges.

They bought universal life because of its high-gross interest rate predictions and the bad publicity surrounding whole life as interest rates rose to those high levels in 1980. What was most damaging was that policy­holders determined the amount of money that they would put into the universal life policy based on those assumptions about high interest rates. As a result, they minimized their annual deposits and under-funded their contracts.

As interest rates have decreased and the policy earnings on their accounts have diminished, many of these policy owners are finding that the earnings on their accounts are not sufficient to cover mortality and expense charges. A portion of the principal in the policy account is being utilized to cover these costs, and so their policy accounts are being systematically eliminated. Also, some policy owners treat universal life as they did whole life they put the policies away and forget them.

They may be totally unaware of decreases in the principal amount of their account values. Unfortunately, they will be shocked when they are notified by the insurance company that their policy account has diminished to a level that cannot sustain the policy and that more money will be required if the policy is to stay in force. These policy owners will receive a call on their policies similar to a call on margin accounts from stockbrokers. This is why you need to make a conscious decision about the funding level in your universal life policy and then watch it to make sure it is doing what you want it to do.