Whole vs. Universal Life Insurance: An Overview

Whole life insurance caters to long-term goals, offering consumers consistent premiums and guaranteed cash value accumulation. Universal life insurance gives consumers flexibility in the premium payments, death benefits, and the savings element of their policy.

These two types of life insurance fall under the blanket of permanent life insurance. Unlike term insurance—which guarantees a death benefit payout during a specified time period—permanent policies provide lifetime coverage. If, for whatever reason, you want to cancel your permanent life policy, you will get your cash value in hand and can use it at the time of emergency.

These policies are typically comprised of two parts: a savings or investment portion and an insurance portion. This makes the premiums higher than normal policies. Insured people can also take a loan by borrowing against the cash value. For this reason, permanent life insurance is also known as cash-value insurance.

Below, we take a look at the two types of permanent life insurance: whole and universal.

Whole Life Insurance

Whole life insurance covers you as long as you live. You have to pay the same amount of premium for a specific period to receive the death benefit. Normally, this policy remains intact for the rest of your life, regardless of how long you may live. This policy is highly suitable for long-term responsibilities like a surviving spouse's income needs and/or post-death expenses.

One of the features of this type of life insurance is that it combines coverage with savings. As a result, you may end up paying higher premiums in the beginning, compared to a term life insurance policy. 

Here's how it works. Your insurance company puts part of your money into a high-interest bank 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. In a way, the presence of guaranteed cash values makes this policy worthwhile because you can borrow against your cash value or surrender your policy to get the cash value.

[Important: In order to borrow against the policy, you need a substantial cash value, as you can't borrow against the policy's face value.]

You can also opt to participate in the surplus of your insurance company and receive the dividends annually. Here again, you have the choice to either get your dividends in cash or let them accumulate interest. You may also use your dividends to reduce your policy's premiums or buy additional coverage.

Whole life insurance is made to fulfill an individual's long-term goals and it is important that you keep it going for as long as you live. It is advisable to buy whole life insurance when you are younger in order to afford it in the long term. Unlike term insurance, the level premiums, fixed death benefits and the attractive living benefits (like loans and dividends) make this policy quite expensive.

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Permanent Life Policies: Whole Versus Universal

Universal Life Insurance

This policy is also termed "adjustable life insurance," because it offers more flexibility compared to whole life insurance. You have the liberty to reduce or increase your death benefit, and to pay your premiums at any time in any amount (subject to certain limits) after your first premium payment has been made.

With a universal policy, you can increase the face value of your insurance coverage. But, you need to pass a medical examination to qualify for this benefit. Similarly, you may decrease your coverage to a minimum amount without surrendering your policy. But keep in mind, surrender charges may be applied against the cash value of your policy.

When it comes to the death benefit, you have two options: a fixed amount of death benefit or an increasing death benefit equal to the face value of your policy, plus your cash value amount.

You also have the opportunity to change the amount and frequency of your premium payments. This means you can increase your premiums or pay a lump sum according to the specified limit in the policy. As you know, part of your premium minus the cost of insurance is put into an investment account—any interest accrued is credited to your account. The interest you earn grows on a tax-deferred basis, increasing your cash value.

You can reduce or stop your premiums to use your cash value to pay premiums in case you go through any financial problems. Nevertheless, there should be enough money accumulated in your cash value account to cover the premium payments. Make sure to discuss the status of your cash value fund with your insurance advisor 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.

The alternative of a policy loan is an added perk in universal life insurance. It is important that you do not make repeated withdrawals from your accumulated fund. This may reduce the cash value amount and will render you helpless at the time of genuine need. Another good thing about universal life insurance is that your insurance company discloses the entire cost of insurance to you. This gives you an idea of how your policy works.

The downside of universal life insurance is the interest rate. If the policy performs well, there are chances of potential growth in a savings fund. On the other hand, the bad performance of your policy means the estimated returns are not earned. So you end up paying higher premiums to get your cash value account going. Second, surrender charges may be levied at the time of terminating your policy or withdrawing money from the account.

Universal life insurance offers all-round protection to your loved ones, thanks to its security, flexibility, and variety of investment options. In times of low liquidity, you can alter your premium payments or may even withdraw from your cash value fund. You can also increase or decrease the face value of your insurance as per your circumstances.

Key Takeaways

  • Whole life insurance offers consistent premiums and guaranteed cash value accumulation, while a universal policy provides flexible premiums, death benefits, and a savings option.
  • Whole life policies offer annual dividends which can be accumulated or taken in cash.
  • Universal life insurance policies allow those insured to stop paying premiums stop in the event of any financial problems.
  • You can borrow against the cash value of a whole or universal policy.