Term vs. Universal Life Insurance: What's the Difference?

Term life insurance and universal life insurance have unique pros and cons

Two of the most common types of life insurance are term life and universal life, and each has its own unique advantages and disadvantages.

The main differences are that term life insurance has more affordable premium payments and a set end date, where as universal life insurance premiums are significantly more expensive, but they last for the life of the policyholder. Universal life insurance also has a cash value component that policyholders can access for other uses.

Learn about the differences between these two types of life insurance in more detail so you can choose which one would work best for your needs.

Key Takeaways

  • Term life insurance covers the policyholder for a specific period of time, such as for 10 or 20 years.
  • Universal life is a type of permanent coverage that can last for the policyholder's lifetime.
  • Term life insurance is significantly more affordable than universal life insurance.
  • Universal life also has a savings component, called its cash value, that the policyholder can access for other purposes.
Term vs. Universal Life Insurance

Investopedia / Sabrina Jiang

How Term Life Insurance Works

Term life is the most basic type of life insurance policy. It provides coverage for a specific period of time. If you maintain premium monthly or annual payments, which are generally more affordable than permanent policies, your beneficiaries will receive a payment if you die before the term ends. Some policies include coverage for dismemberment and additional coverage for accidental death.

After a specified number of years — typically 10, 20, or 30 years — term insurance policies expire. However, some insurers allow you to continuation the policy, typically at a higher rate. Or you can sometimes convert a term policy into a permanent policy, which has no expiration date.

Generally, term life insurance is cheaper when policyholders are younger and their risk of death is lower. Prices typically rise in accordance with advancing age and increased risk.

Term life insurance is often offered as an employee benefit. If you're shopping for a policy on your own, check one or more of the major ratings agencies— Fitch, Moody’s, or Standard & Poor’s—to make sure you're dealing with a reputable company. You can also review Investopedia's annual list of the best term life insurance companies.

How Universal Life Insurance Works

Universal life insurance is a type of permanent life insurance, or cash value insurance. These type of insurance policies have a death benefit that is paid to beneficiaries when the policy holder dies, but they last for the life of the owner.

Universal life insurance also has a savings component, or cash value, that builds up over time on a tax-deferred basis. You can often access the cash value such as through a life insurance policy loan and use the money toward other expenses.

Universal life insurance policies are designed to last until the policyholder's death, and you are usually subject to penalties if you terminate the policy early.

During the initial years of the policy, a large portion of the premiums paid by the policyholder will go toward the savings component. During the later years, when the policyholder is older and the cost of insuring them is higher, more of each premium will go toward the cost of insuring them and less into savings.

Example of How Term and Universal Life Insurance Differs

With term insurance, rates tend to increase as you age whereas universal life insurance premiums remain the same. For example, if a 21-year-old buys term insurance, their premium might be $20 per month for a certain amount of coverage.

With a universal policy, the 21-year-old might pay $100 a month for the same amount of coverage, with $20 going toward death benefits and the remaining $80 toward savings.

When the person reaches age 45, term insurance might cost $50 per month, while universal life would still cost $100 per month, although a lower portion of that amount would go into the cash savings component and more would be used to compensate for increased risk.

Special Considerations

Term life insurance is appropriate for the average person looking to insure themselves and their loved ones against unforeseen events. That is especially true for young families on a budget, in part because for the same amount of money they can buy a much larger term policy.

The fact that term insurance eventually ends may fit some people's needs. For example, parents of children who are grown and financially independent may no longer need life insurance.

However, term life is not necessarily the best choice for everyone. For example, individuals who would benefit from the tax advantages of permanent insurance may be less concerned with the higher costs of those plans.

What happens to term life insurance at the end of the term?

Most life insurance policies have an end date when the policy terminates and you no longer receive coverage. When that happens, you can renew the policy although the rate is likely to be higher. In some cases, you can convert a term life insurance policy to a permanent life insurance policy.

What is the disadvantage of whole life insurance?

The biggest downside to whole life insurance is the fact that premium payments are significantly larger. For some people, a whole life insurance policy may not be affordable. Whole life insurance can also be more complex with its cash value component.

What age is best to buy whole life insurance?

The right age to buy whole life insurance will depend on your financial situation and personal goals. The younger you are, the better rate you can get, so in general it's better to try to buy whole life insurance at an earlier age.

The Bottom Line

Term and universal life insurance both have unique pros and cons to consider. Keep differences such as premium costs and term lengths in mind when you determine which policy may be right for you. For more personalized guidance, consult a professional financial advisor who can guide you through how each policy would fit into your personal financial situation.

Article Sources
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