Knowing the advantages of any given policy is a vital step in making the right decision. However, disadvantages should also be addressed to help make the most educated decision. Below are 5 common disadvantages to an adjustable life (AL) insurance policy:
- Some AL policies, similar to many ordinary whole-life policies, use what is called the direct recognition method to determine how favorable investment, mortality, and expense experience is allocated to dividends on policies with policy loans. Under this method, the insurance company reduces the amount of dividends allocated to policies with policy loans to account for the generally lower yield the company earns on policy loans relative to other investments in their general portfolio. Companies most commonly use the direct recognition method in policies with fixed policy-loan rates. Typically, policies with variable-loan rates, and some others with fixed-loan rates, do not employ the direct recognition method and instead allocate dividends without regard to loans. There are also some AL policies that do not have dividends, but credit current mortality and interest to cash values, similar to UL.
- Lifetime distributions or withdrawals of cash values are subject to income tax to the extent attributable to gain in the policy.
- Surrender of the policy within the first five to ten years may result in considerable loss because cash surrender values reflect the insurance company’s recovery of sales commissions and initial policy expenses.
- Interest paid on policy loans generally is nondeductible.
- The flexibility with respect to premium payments and death benefits permits policyowners to change the policy in such a way that it may inadvertently become a modified endowment contract (MEC) with adverse tax consequences.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM