Those shopping for the right life insurance policy have a wide array of choices, ranging from cheap term life insurance to expensive whole life insurance policies. When it comes to permanent life insurance policies, two popular options are whole life insurance and index universal life insurance (IUL). Individuals deciding between these options should carefully examine their needs before committing to a life-long decision. (For more, see: Life Insurance: Putting a Price on Peace of Mind.)

In this article, we’ll take a look at the key differences between these policies and some tips for individuals trying to decide between them.

Whole Life Insurance

Whole life insurance policies have been around for decades, guarantee a benefit, and have predictable premium payments that don’t increase with age. In general, these policies are considered the safest option for those looking to provide for their families after death. (For more, see: Whole Life Insurance.)

Benefits

  • Guaranteed benefits
  • Fixed premiums that don’t increase with age
  • Option to pay up face value in 10 years, 20 years, or at age 65
  • Option to borrow against if needed later in life

Drawbacks

  • Interest rate may not be guaranteed
  • Potential opportunity cost with low interest rates
  • Premiums aren’t flexible and must be paid consistently

Indexed Universal Life Insurance

Indexed universal life insurance policies are relatively new policies that provide a guaranteed benefit, earning potential tied to an equity index, and flexible premium payments. In general, these policies are riskier and more complex options geared towards retirement planning. (For more, see: What is Indexed Universal Life Insurance?)

Benefits

  • Guaranteed benefits
  • Flexible premium payments
  • Potential for higher interest earnings
  • Option to borrow against later in life

Drawbacks

  • Earnings depend on equity performance
  • Potential for premiums to rise over time
  • Use of complex derivative investments

Deciding Between the Two

Whole life insurance is designed to be exactly that – life insurance. In many ways, indexed universal life insurance policies are retirement planning vehicles. Cash inside of these policies grows on a tax-deferred basis and the cash value can be used to pay premiums. During retirement, policyholders can take tax-free distributions to help cover the costs of retirement for those that have already maxed out their Roth IRA and other options.

It’s also important to consider the use of derivatives by indexed universal life insurers. Since a call option is inherently capped at a certain level or expire worthless, IUL policies have limitations to the maximum returns during good years and limit downside to 0% returns during bad years. Insurance providers touting high returns for IUL policies may be trying to take advantage of “recency bias” if equity indexes have been performing well as of late. (For more, see: Life Insurance: How to Get the Most Out of Your Policy.)

Aside from reading the fine print, IUL policyholders should not rely on high equity index returns to fund their life insurance over time. High returns in some years can lead to policyholder neglecting to fund the cash value of the policy, which could lead to a lapse in coverage later in life if returns aren’t quite as good. Taking policy loans from the cash value and paying interest can also be a risky endeavor if the credited interest doesn’t cover the costs of the loan.

The Bottom Line

Individual shopping for a life insurance policies have a number of different options. While term life insurance is generally the cheapest option, whole life and indexed universal life insurance policies provide a cash value alternative. Whole life is generally the safest route for those looking for something predictable and reliable, while IUL policies provide an interesting retirement planning vehicle with greater upside potential and tax advantages. (For more, see: 5 Life Insurance Questions You Should Ask.)

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