Whole Life vs. Universal Life Insurance: An Overview
These two types of life insurance both fall into the category of permanent life insurance. Unlike term insurance, which guarantees a death benefit payout during a specified period, permanent policies provide lifetime coverage. If you cancel your permanent life policy, you will receive the policy's cash value (minus any fees).
These types of life insurance policies are both typically comprised of two parts: a savings or investment portion and an insurance portion. This makes the premiums higher than those for term policies. Policyholders can also borrow against the cash value of the policy. For this reason, permanent life insurance is also known as cash-value insurance.
While similar in some respects, whole life and universal life insurance policies have some key differences. Whole life insurance offers consistency, with fixed premiums and guaranteed cash value accumulation. Universal life insurance gives consumers flexibility in the premium payments, death benefits, and the savings element of their policies. Here, we'll look deeper into each of these types.
- Whole life and universal life insurance are both types of permanent life insurance.
- Whole life insurance offers consistent premiums and guaranteed cash value accumulation, while a universal policy provides flexible premiums and death benefits.
- You can borrow against the cash value of a whole or universal policy.
Whole Life Insurance
Whole life insurance covers you for the rest of your life, regardless of how long you may live. As long as you keep paying the premiums, your beneficiaries will receive the death benefit when you die. This policy is highly suitable for long-term responsibilities such as a dependent adult child's care or post-death expenses like estate taxes.
How Whole Life Insurance Works
One of the features of this type of life insurance is that it combines coverage with savings. Your insurance company puts part of your premium payments into a high-interest bank account or investment account. With every premium payment, your cash value increases. This savings element of your policy builds up your cash value on a tax-deferred basis. Whole life insurance is made to fulfill an individual's long-term goals and it is important to keep it going for as long as you live.
To borrow against the policy, you must meet a minimum cash value requirement, as you can't borrow against the policy's face value.
Pros and Cons of Whole Life Insurance
One attractive feature of whole life policies is the guaranteed cash value. Since you can borrow against it—or surrender your policy to get the cash value—it offers some financial flexibility in the case of an emergency.
The dividends your company offers give you some flexibility as well. You can opt to receive them annually in cash, let them accumulate interest, or use them to reduce your policy's premiums or buy additional coverage.
However, the level premiums, fixed death benefits, and attractive living benefits (e.g., loans and dividends) make this policy quite expensive, especially compared to term insurance. It is advisable to buy whole life insurance when you are younger to be able to afford it in the long term.
Related: The Best Whole Life Insurance
Universal Life Insurance
Universal life insurance is also called adjustable life insurance because of the flexibility it offers. You have the liberty to reduce or increase your death benefit and pay your premiums at any time in any amount (subject to certain limits) once there is money in the account.
How Universal Life Insurance Works
When you make a payment to your universal life insurance plan, part of it goes into an investment account, and any interest accrued is credited to your account. The interest you earn grows on a tax-deferred basis, increasing your cash value.
You can adjust the death benefit when needed, increasing it (often subject to a medical exam) if your circumstances change, or lowering it to reduce premiums. Alternatively, you can use your cash value to pay premiums as long as there is enough money in that account.
Pros and Cons of Universal Life Insurance
The ability to adjust the face value of your coverage without surrendering your policy is an attractive feature of universal life coverage. As your financial circumstances or responsibilities change, you can increase, decrease—or even stop—premium payments.
Make sure to discuss the status of your cash-value fund with your insurance adviser or agent before stopping the premiums. Your policy may lapse if you cease to pay premiums and have insufficient cash value to cover the cost of insurance.
Another perk is the ability to partially withdraw or borrow funds from the cash value. However, you must not make repeated withdrawals as this may reduce the cash value amount and leave you little in the time of need.
The main downside of universal life insurance is the interest rate, which is often dependent on market conditions. If the policy performs well, there are chances of potential growth in your savings fund. On the other hand, if it performs poorly, the estimated returns are not earned. Another negative feature: the fees: Surrender charges may be levied at the time of terminating your policy or withdrawing money from the account.
Related: The Best Universal Life Insurance
Deciding What's Right For You
The right life insurance for you will depend on your family structure and financial situation as well as your appetite for risk and desire for flexibility. In addition to universal and whole life, you can also explore other forms of life insurance such as term, group life insurance, and more.