Term vs. Universal Life Insurance: An Overview

Life insurance comes in various forms, and two common types are term life and universal life. The main differences between them are the length of the policy, whether it accumulates a cash value, and how much it's likely to cost.

Key Takeaways

  • Term life insurance covers the policyholder for a specific period of time, such as 10 or 20 years.
  • Universal life is a type of permanent coverage that can last for the policyholder's lifetime.
  • In addition to a death benefit (like a term life policy), universal life also has a savings component that builds up over time.

Term Life Insurance

Term life is the most basic type of life insurance policy, and it simply provides coverage for a specific period of time. Some policies include coverage for dismemberment and additional coverage for accidental death.

After a specified number of years—such as 10, 20, or 30—term insurance expires. However, some insurers allow for the continuation of the policy at a higher rate or for the conversion of the term policy into a permanent policy, with no fixed expiration date. Generally, term life insurance is cheaper to buy when policyholders are younger and their risk of death is relatively low. Prices can rise in accordance with advancing age and increased risk.

Term life insurance is often available to workers as an employee benefit. If you're shopping for a policy on your own, check one or more of the major ratings agencies—A.M. Best, Fitch, Moody’s, and Standard & Poor’s—to make sure you're dealing with a financially sound company that's likely to be around if you ever need it. Investopedia also publishes annual lists of the best term life insurance companies.

Universal Life Insurance

Universal life insurance falls into the broader category of policies referred to as permanent or cash value insurance. These types of insurance policies combine a death benefit (like a term policy) with a savings component or cash value that builds up over time on a tax-deferred basis. The savings portion can often be cashed in or borrowed from at some future point.

Because these policies are meant to be permanent, policyholders are usually subject to penalties if they 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 purchase of insurance and less into savings.

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 savings.

Dollar for dollar, policyholders can usually buy a much larger death benefit with term life insurance.

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 comes to an end may not be a downside, either. Once children are grown and financially independent, parents may need little to no life insurance.

However, this does not mean term life is better 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 are basic things to consider when deciding between universal or term insurance?

Term is the most basic life insurance and it expires after a specified number of years. It will cover policyholders during the years when it's most needed and dollar for dollar, it provides a bigger death benefit than universal. Universal combines the death benefit with a savings portion that builds up over time tax-deferred. The policy permits borrowing against, or cashing in, the savings.

What about those ratings? Who rates the term life insurance companies?

Major ratings agencies—A.M. Best, Fitch, Moody’s, and Standard & Poor’s—will analyze insurance companies to make sure they are financially sound and able to meet their obligations. Check the ratings and be sure you're working with a company that's likely to be around for a while.