What are the main problems of universal life insurance?

Universal life insurance (UL) may appear attractive due to its flexibility and built-in investment component, but it comes with several significant drawbacks that make it a poor fit for many Canadians. The main problems of universal life insurance include rising premiums over time, non-guaranteed investment returns, complex fee structures, and the risk of policy lapse if not properly funded.

While it’s often used for estate planning or tax-deferred cash value growth, the long-term risks and complexity can outweigh the benefits, especially if the policy is not actively managed. In this blog, we’ll break down how universal life insurance works and take you through the potential pitfalls to be aware of.

What is universal life insurance?

Universal life insurance (UL) is a type of permanent life insurance that provides lifelong coverage and builds cash value over time. When you pay premiums every month, the insurer usually splits them into two parts. 

One part covers the cost of insurance (COI), and the other part goes into an investment option such as stocks, bonds, or mutual funds, etc. This investment value will grow based on interest rates or market conditions.

What sets universal life insurance apart is its flexibility. You can adjust your premium payments or even change the death benefit amount if your needs change. As the cash value grows, you may also use it to pay future premiums or make withdrawals. However, tapping into the cash value can reduce the final payout to your beneficiaries.

Some of the main benefits of universal life insurance include:

• Lifelong protection: Your policy remains active for life, as long as you continue making the required premium payments
• Tax-deferred growth: The investment portion of your policy grows without immediate tax implications, helping your savings accumulate faster
• Flexible premiums and benefits: You can adjust your premium payments and death benefit amounts to suit your changing financial needs
• Cash value access: You can borrow or withdraw from the policy’s cash value during emergencies or major life events

Main problems of universal life insurance

Some of the major problems with universal life insurance can be one of the following: 

• Investment returns aren’t guaranteed
• Premiums continue to rise with age
• Complex fee structure
• The risk of policies lapsing if underfunded
• The need for constant monitoring and management
• Might not be the best fit for average Canadian residents 

Let’s explore how these problems can erode your cash value growth, impact your premium, and ultimately cause your policy to crumble in the long term.

1. Investment returns are not guaranteed

Universal life insurance includes an investment feature, but those returns aren’t locked in. Your money is typically placed in fixed-rate or market-linked accounts, like index funds or investment portfolios.

If your investments underperform, your policy may not grow as expected. You might need to pay higher out-of-pocket premiums just to keep it active. But if markets dip or fees eat into gains, they might face unexpected costs at a time when income is limited.

This becomes a serious issue if you’re depending on the cash value to help fund your retirement or pay ongoing premiums. A weak market doesn’t just lower your savings today—it can put your entire coverage at risk later.

It’s important to track your policy’s performance regularly to make sure your universal life insurance policy still fits your long-term goals.

2. Complex fee structure

Universal life insurance may look flexible on the surface, but the fees hidden beneath can quickly decrease your returns. These policies often include several charges that aren’t always easy to understand.

Here are some of the most common fees included in a universal life insurance policy:

• Cost of insurance (COI): This charge covers the pure life insurance portion of your policy and increases as you age.
• Policy administration fees: Insurers charge an administration fee every month to cover their operational costs.
• Investment management fees: If your policy includes market-based investments, you’ll pay additional investment management fees.
• Surrender charges: If you cancel the policy in the early years, you may face steep penalties for withdrawing your money.

Although the initial projections showcase high cash value growth, once you factor in all the fees, the actual return may be far lower. If the market underperforms or if you reduce your premium payments, these fees will impact your cash value growth and even put your coverage at risk.

3. Rising cost of premiums with age

Universal life insurance allows you to adjust your premium payments, but the cost of insurance (COI) increases as you age. This is because your risk of death increases with age, and insurers charge more to cover that risk.

This rising cost can put pressure on your policy’s cash value. If the cash value can’t keep up with the growing COI, and you don’t make extra payments, your policy could start to drain itself. Eventually, you might be forced to pay much higher premiums just to keep the coverage active.

This creates a serious issue during retirement, when your income might be fixed or limited. For many older policyholders, the policy becomes unaffordable. Some individuals even face the difficult decision of letting their policy lapse after paying premiums for decades.

4. Risk of policy lapse if underfunded

UL policies require ongoing premium payments to stay active. If your policy fails to grow substantial cash value over time, you may risk facing a policy lapse. This means you lose your life insurance protection altogether.

Unlike whole life insurance, where premiums are fixed, UL insurance requires more constant involvement. If the policy lapses due to insufficient funds, the coverage ends, and you might owe taxes on the cash value.

5. Requires ongoing monitoring and management

Universal life insurance is the kind of product that requires regular review and active management to ensure that your finances and cash value growth are on track. With a UL policy, you might need to:

• Monitor your investment performance
• Adjust premiums as and when needed
• Reevaluate coverage and death benefits if your requirements change
• Consistently monitor policy fees

This can be time-consuming, especially if you’re not financially savvy or don’t work with a financial advisor. Unlike term life or whole life policies, which are more predictable, UL policies demand your attention year after year.

6. Not the best fit for everyone

Universal life insurance is often promoted as a wealth-building tool, but it’s not suitable for everyone. For most Canadians, a combination of term life insurance or whole life insurance, along with a group retirement savings plan, may provide a better return and simpler financial planning.

UL insurance is more suitable for high-net-worth individuals who have already maxed out other tax-advantaged accounts and need a long-term estate planning tool. For the average Canadian family, though, it may be too complicated, costly, and risky.

Who is universal life insurance best suited for?

Universal life insurance is generally best for individuals who are looking for flexibility and long-term financial planning. It is especially beneficial for high-net-worth individuals, people looking for corporate-owned life insurance, individuals with large estates, and the ones who have hit their RRSP contribution limits.

• High-income earners seeking tax-sheltered growth
• Business owners looking for corporate-owned life insurance 
• Individuals with large estates who want to pass on wealth tax-efficiently
• Individuals who have already maxed out their TFSA and RRSP contribution limits

If you fall into one of these categories, universal life insurance can be a powerful tool. However, it must be managed with guidance from a qualified advisor to ensure it aligns with your overall financial goals.

Can I switch from universal life insurance to another type of policy?

Switching from universal life insurance to a different type of policy, such as term or whole life insurance, is possible. Some insurers offer policy conversion options, but these depend on the terms of your original contract as well as your current health and financial situation.

Here are a few things to keep in mind when you are switching from a universal life insurance policy:

• You may lose some or all of your accumulated cash value if the new policy doesn’t include a cash value component
• New underwriting may be required, especially if you’re applying for a different policy type. If your health has worsened during this time, your premiums could be significantly higher
• Surrender charges or tax consequences may apply if you cancel your universal life insurance policy or withdraw cash value

It is best to speak to an advisor before you switch from a universal life insurance policy to any other option.

What happens if the cash value in a universal life policy runs out?

If the cash value runs out in a UL policy, and you don’t make additional premium payments, your policy can lapse. This means your coverage ends, and you lose any benefits associated with the plan.

You might also owe taxes if the total withdrawals and investment earnings exceeded the premiums you paid. This is a major downside of relying too heavily on the cash value to fund premiums without monitoring its performance.

Can insurance companies change the terms of a universal life policy after it’s issued?

Insurance companies cannot arbitrarily change the contractual terms of your policy once it’s issued. However, they can:

• Adjust the interest rates for investment accounts (within set limits)
• Modify administrative or cost of insurance fees based on policy wording
• Change available investment options

This means while your death benefit and policy structure remain intact, the internal costs or investment returns may shift, affecting your cash value and performance.

What are some alternatives to universal life insurance in Canada?

If universal life insurance doesn’t meet your needs, several other options may offer better simplicity, predictability, or savings potential. These include term life insurance, non-participating and participating whole life insurance, as well as individual RRSPs.

• Term life insurance: Offers straightforward, affordable coverage for a set period (e.g., 10, 20, or 30 years). It’s ideal if you want protection during high-responsibility years, like when raising a family or paying a mortgage
• Non-participating whole life insurance: This provides lifelong coverage with fixed premiums and a guaranteed death benefit, but without dividends. 
• Participating whole life insurance: This includes a savings component that may earn dividends, offering the potential for cash value growth over time. It’s useful for long-term wealth transfer or estate planning
• Individual Registered Retirement Savings Plans (RRSPs): RRSPs are tax-deferred investment accounts that can help you save for retirement more flexibly and transparently than universal life policies

How to get the best life insurance quotes in Canada?

To get the best life insurance quotes in Canada, it’s important to compare multiple plans based on your unique needs, health profile, and financial goals. However, it doesn’t have to be so overwhelming. 

PolicyAdvisor’s AI-powered quote calculator delivers accurate and customized quotes in under 60 seconds, giving you instant quotes from the top life insurance providers. Our team of licensed advisors can guide you every step of the way, helping you understand your options and choose a plan that fits your lifestyle, goals, and budget. 

The best part? Our commitment doesn’t end after you purchase a policy. PolicyAdvisor offers lifetime after-sales support, so whether you need to update your policy, ask questions, or explore other coverage in the future. Schedule a call with us today to get instant quotes!