Whole Life vs. Universal Life Insurance

Knowing their pros and cons will help you decide what's right for you

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 (UL), 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.

Key Takeaways

  • Whole life and universal life (UL) insurance are both types of permanent life insurance.
  • Whole life insurance offers consistent premiums and guaranteed cash value accumulation.
  • Universal policies provide flexible premiums and death benefits but have fewer guarantees.
  • You can borrow against or withdraw the cash value with both a whole or universal policy.
  • In general, a whole life policy will have higher premiums than an equivalent UL 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.

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.

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.

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.

Key Differences

The biggest difference for policyholders between whole life and UL is the guarantees. Whole life has a guaranteed death benefit, level premiums, and growing cash value. This growth in cash value comes from annual dividends that are credited to policies.

Universal life provides flexibility in lieu of guarantees. You can pay more or less each year for your policy, and this will also allow the cash value and death benefit to fluctuate. Rather than dividend payments, UL policies are credited based on interest rates. This can lead to a UL policy becoming underfunded, causing premiums to rise. If those payments cannot be met, the policy can terminate.

With whole life, you pay higher premiums for the guarantees you are given. An equivalent UL policy will cost less, but also carry a certain degree of risk to policyholders.

Whole Life vs. Universal Life: Key Differences
Whole life Universal life 
Fixed premiums Flexible premiums 
Guaranteed death benefit May allow you to increase or decrease the death benefit
Offers cash value to use while you're still living  Offers cash value potential
Dividends are guaranteed Interest rates can change over time 
Higher premiums Lower premiums
Can never become underfunded May become underfunded and lapse
Whole Life vs. Universal Life: Key Differences

Special Considerations

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.

Regardless of which type of policy you decide on, be sure to compare the companies you're considering as well to ensure you're getting the best whole life insurance or the best universal life insurance possible.

What Is Term Life Insurance?

Term life insurance is a low-cost option that provides a death benefit for a given number of years (the term), such as 10 or 20 years. Term policies, unlike whole or universal life, do not accumulate any cash value. Term life is often the cheapest option.

What Is Indexed Universal Life Insurance?

Indexed universal life (IUL) is a variation of universal life (UL), whereby the cash component of the policy is linked to the performance of a stock market index, such as the S&P 500. The policyholder decides how much cash value to assign to either a fixed account or the equity-indexed account. There will be a cap above which the policy will no longer credit the account, such as 12% per year. Thus, even if the S&P grows 20% in a given year, the policy will only earn 12%. Moreover, if the index falls, returns can be inferior, though there are often floors to prevent extreme losses.

How Long Does Universal Life Last?

As long as a universal life policy is fully-funded and premiums are paid on time, a universal life policy will be in force permanently, until one's death.

Can You Convert a Term Life Policy Into Whole Life?

Depending on the insurance company and conditions of a term policy, you may be able to convert it into permanent coverage without needing a new medical exam. The new whole life policy will come with higher premiums, based on the age you are when you do the conversion.

Article Sources
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