All of the following statements about universal life insurance are true EXCEPT
A) Interest is credited to the policy’s cash value each month.
B) Any withdrawal of a policy’s cash value reduces the amount of the death benefit.
C) Interest credited to a policy’s cash value is taxable for the policy owner in the year credited.
D) The policy owner can add to a policy’s cash value at any time subject to policy guidelines.
The Correct Answer and Explanation is:
The correct answer is C) Interest credited to a policy’s cash value is taxable for the policy owner in the year credited.
Explanation:
Universal life insurance is a flexible, permanent life insurance policy that allows policyholders to adjust their premium payments and death benefits. It also has a cash value component that grows over time, earning interest. However, one of the key features of universal life insurance is the way it handles interest and the tax implications associated with it.
A) Interest is credited to the policy’s cash value each month.
- This statement is true. Universal life insurance policies typically credit interest to the cash value on a monthly basis. The interest is based on the insurer’s declared interest rate, which may vary but is generally competitive. The interest helps the policy’s cash value grow over time.
B) Any withdrawal of a policy’s cash value reduces the amount of the death benefit.
- This statement is true. Withdrawals or loans taken from the cash value of a universal life policy will reduce the death benefit. The death benefit is typically the amount of insurance coverage minus any outstanding loans or withdrawals from the cash value. This ensures that the policyholder or their beneficiaries are aware of the change in the death benefit after accessing the cash value.
C) Interest credited to a policy’s cash value is taxable for the policy owner in the year credited.
- This statement is false. In a universal life insurance policy, interest credited to the policy’s cash value is generally not taxable until the policyholder withdraws the funds or surrenders the policy for cash. This tax-deferral feature is a significant benefit of universal life insurance, similar to other types of permanent life insurance. The interest accumulates tax-deferred, meaning the policyholder does not have to pay taxes on the credited interest until it is withdrawn or the policy is cashed out.
D) The policy owner can add to a policy’s cash value at any time subject to policy guidelines.
- This statement is true. One of the flexible features of universal life insurance is the ability for the policyholder to make additional contributions to the policy’s cash value. These additional contributions, subject to certain limits set by the insurer, can be made at any time, allowing the policyholder to increase their cash value and potentially increase the death benefit as well.
Thus, C is the only incorrect statement. The interest is not taxed when it is credited to the cash value but is taxed upon withdrawal or policy surrender.