Experts warn against using universal life for retirement income (continue)

The benefit of using leveraging instead of a direct cash withdrawal is that it is non-taxable under the current tax rules. "The intention of doing the borrowing is you wait until you die and the death benefit, which you know is tax free, pays off the loan and whatever is left goes to your beneficiary," points out Mr. Crozier.

He adds that this way, clients get 25% to 30% more after-tax income as opposed to doing it the old-fashioned way, which is withdrawing from the policy. "The loan will always be less than the cash value and they will both grow in parallel. Although you generally have to watch it a little bit because the interest that you earn on the policy is generally less than the interest you were charged on the loan rate."

High taxes
As for withdrawing funds directly from the policy, "the money is a blend of capital and interest and the interest portion is taxable and the capital portion of course is not," explains Mr. Crozier.

The withdrawing cash option allows for a tax-sheltered growth of money and the excess deposits can be linked to various indexes such as equities, bonds and guaranteed interest accounts. But the downside, says Rob Haiman, advisor for Assante Estate and Insurance Services, is "when you pull that cash out directly from the product, it becomes taxable the same as interest income, it'll be taxed at the highest rate."

Mr. Cappon says there is no advantage in utilizing UL to produce retirement income when you're not leveraging due to the heavy taxation.

He adds that most consumers do not realize that they are going to pay tax on the other end on their capital once they pull out. "I don't think the industry or the agents have done a very good job in pointing out how the adjusted cost base works," he expresses.

However, if a client has a UL policy and is also on disability (or critical illness depending on the broadness of the company's definition of disabled), the fund value could be withdrawn tax-free.