Universal Life Insurance

Thinking Again About Variable Universal Life Insurace

Beware of the potentia pitfals of variable universal life insurance before you buy. If you are not careful, the high fee and potential tax implications can haunt you for the rest of your life.

So what, possibly, could be wrong with such a sunny scenario?

Well, for one thing, these policies are usually larded with fees that can drag down the return you eventually earn. Many charge upfront sales "loads" or commissions that can range from 5% to nearly 10% of what you put into the policy.

The investment options in the policy also charge annual management fees. No surprise there; so do mutual funds. But unlike mutual funds the investment portfolios in the policy have another layer of insurance fees that can run almost as high as 1 percent per year in the initial years of the policy. The result is that you could end up paying upwards of 2 percent a year in annual costs (that's on top of the sales commission).

And let's not forget that you're also buying insurance protection. Again, no surprise since this is an insurance policy, after all. The rate you pay, however, can be much, much higher than you would pay for a comparable amount of coverage on a basic term policy.

When you combine all these fees, it's not uncommon to find that it can easily take five or more years before your cash value - what you would receive if you cashed out the policy - exceeds the premiums you've paid in. And even if you hold the policy for many, many years, those fees are dragging down your returns.

Of course, the sales person will point out that by borrowing against the policy you sidestep taxes. Which means you're dramatically raising your after-tax rate of return. There's one complication, though. Once you start borrowing against the policy, you've got to keep paying premiums to keep the policy in force. If you let it lapse, you could be in for a horrendous tax nightmare.

So, for example, if you've pulled a hundred grand or more out of the policy during retirement and suddenly find yourself at age 75 or 80 unable to pay the annual premium, the policy could lapse and all the investment earnings you borrowed from the policy over the years would be taxed at ordinary income rates.

In short, you could face one huge tax bill at a time when you're probably least able to handle it.

Given the expenses, the complications and the potential tax headache late in retirement, I'm not a big fan of using variable universal life (or any other type of insurance policy, for that matter) as an investment vehicle to save for retirement.