What is the difference between term and universal life insurance?

By Investopedia Staff AAA
A:

Term life insurance is the most basic of insurance policies. It is nothing more than an insurance policy that provides protection for accidental death and possibly debilitating injuries for a specified period of time. If you or your beneficiaries do not make any claims during the term of such a policy, the policy will typically expire worthless. Generally, term life insurance is cheaper to buy during the earlier years of life, when the risk of death is relatively low. Prices rise in accordance with increasing risks and advancing age.

Universal life insurance falls under a broader category of policies sometimes referred to as cash-value, or permanent, insurance. These types of insurance policies combine death benefits with a savings component or cash value that is reinvested and tax deferred. The savings portion is accumulated throughout the life of the policy and can sometimes be cashed in at some future point. Because these policies are permanent, any early termination of the contract by the policy holder is subject to penalties. During the earlier stages of your life, a large portion of the premium paid to this policy is routed to the savings component. During the later stages of life, when the cost of insurance is higher, less of the premium is devoted to the cash portion and more to the purchase of insurance.

For example, if a 20-year-old adult purchases term insurance, his or her premiums might be $20 per month. With a universal policy, the same 20 year old might pay $100 a month, with $20 of that going toward death insurance and the remaining $80 going to the savings component. When the person reaches age 45, term insurance might cost $50 per month; however, with universal insurance, the person would still pay $100 a month, although a lower portion of this would go into the savings component.

According to most unbiased experts, term life is more appropriate for the average individual looking to insure him or herself against unforeseen events. However, this does not mean that term life is better for everyone. For example, individuals looking for the tax advantages associated with cash-value plans are not concerned with the prohibitive costs related to those plans, and individuals who start families later in life and need insurance to protect their loved ones may also decide that cash-value insurance is more suitable than term life.

To learn more, read Buying Life Insurance: Term Versus Permanent.

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