Whole life vs universal life insurance. What are the key similarities and differences?

Life insurance fills a unique role: when you can no longer be there for your loved ones, the life insurance company will deliver an income tax-free check to your beneficiaries.¹ While this money can never replace you, it can help them live the kind of life you hoped to provide.

What are the major types of life insurance?

All life insurance can help provide you financial confidence that your family will have financial stability in your absence. However, there are several types of life insurance, and it’s important to understand the benefits of each type based on your needs and how they compare.

Term life insurance: how does it work?

The least complex form of life insurance is called term. A term life insurance policy provides coverage for a set period of time (e.g., a term you choose), for whatever benefit amount you select. When that period is over, usually 10-30 years, so is the coverage. For many, term insurance can be an economical and temporary form of financial reassurance. Coverage can sometimes be renewed after the initial term expires, although typically at a much higher cost and, in most cases, after a new required medical exam. Term insurance does not have any component of building a lasting financial asset, but it provides coverage until the term expires.

Permanent life insurance: what is it, and how does it differ from term?

The other primary type of life insurance policy is called permanent life insurance. Life insurance coverage stays with you as long as you’re alive and your payments stay current. Your beneficiaries, whether loved ones or a designated charity, will receive a sum of money when you pass away, no matter when that occurs. The permanent life insurance category has two main variations: whole life insurance and universal life insurance. Within the universal life category, indexed universal life insurance is an option that offers the potential for higher returns by linking the cash value growth to the performance of a stock market index.

How do whole life insurance policies and universal life insurance policies compare?

Both permanent products are life insurance policies that can last your whole life, and in addition to the insurance coverage, both can build a cash value,² which is money that you can use during your lifetime.³ You can’t outlive the guaranteed life insurance protection,⁴ provided that you keep the policy in good shape by making sure that your payments are up to date.⁵ A portion of each premium (the amount you pay for your policy) goes towards building your cash value component over time.

Aside from these similarities, whole life and universal life have several differences. One variety might suit a different type of person better than the other, and ideally, you would consult with a qualified financial professional to figure out which is more in line with your needs. Here, we list a few considerations.

What are the key differences between whole life insurance and universal life insurance in terms of cost?

Whole life costs a guaranteed level amount of money each month

In general, a whole life insurance policy may be suited to the type of person who wants guarantees. A whole life insurance policy tends to cost more to support the guarantees it provides.

You’re buying a financial product that will provide an immediate death benefit and start building up into a permanent asset — and this comes along with several guarantees. These include guaranteed level premium payments, meaning the payments you make each month (or year, if you prefer) won’t ever rise. As the cost of living goes up throughout the years ahead, you can be confident that your whole life insurance premium will remain identical every month and never cost more.

Whole life cash values are guaranteed

In addition to this guaranteed premium, whole life provides guaranteed cash value. As these values build over time, a loan or withdrawal may be taken to cover future premiums, meaning your whole life policy could even become a self-financing asset. Although not guaranteed, you may receive annual dividend payments from the insurance company if it’s a mutual insurance company. Those dividends can boost the cash value even further.⁴

Also, the cash value growth within the policy isn’t taxed as income. The combined package — guaranteed death benefit for your loved ones whenever you pass away and cash value that grows in a tax-efficient way — gives you the flexibility to handle life’s unexpected events. Remember that accessing the policy’s cash value may affect how much your beneficiaries receive after you’re gone.

The cash value you build with whole life insurance is a financial asset you can access and use during your lifetime. You can borrow and withdraw from it to help supplement retirement income, help offset college tuition costs, use it as collateral for a loan and much more. Your cash value will grow at a rate the insurance company guarantees, with potential additional growth provided by a non-guaranteed dividend.

Universal life cash values and premiums can fluctuate

In a universal life insurance policy, the cash value growth is dependent upon the current interest rates associated with the specific type of policy. Indexed universal life insurance policies, in particular, require careful monitoring or policy performance due to their market-linked nature.⁶ Universal life policies will all see different growth patterns. How much premium you pay into the policy and how much you access into the cash value will also play a role in the overall growth.

There is some risk associated with universal life because interest crediting rates, cost of insurance rates, and investment performance can change and will impact your policy. It’s important to consider coverage with a company that offers a guaranteed interest rate. Speak with a financial professional to learn more.

If a universal life policy is underfunded, meaning the premiums paid are less than the current charges, the difference is then deducted from the cash value. Your policy can lapse depending upon your specific contract. If the cash value falls to a certain point.

You should stay in touch with your financial professional to help ensure that you keep the account and your life insurance coverage in healthy condition.

Whole life potentially provides dividends

If you buy a whole life insurance policy from a mutual insurance company, you may receive annual dividend payments on your policy. These depend upon several factors, including the insurance company’s profitability that particular year, and are not guaranteed. However, some mutual companies may have track records of delivering dividend payments virtually every year with policyholders. Dividends can be reinvested into your policy to help build cash value faster. .

Another financial tactic is to use dividend payments to buy additional insurance and increase the total “death benefit” (the amount of money that will be payable to your loved ones).

You may also use dividends and the additional coverage they purchase to pay all or a portion of your future premiums. Other options are to receive the dividends in cash each year or accumulate them within the policy and withdraw them at a future date.

Note that loans and withdrawals from the policy can reduce the amount of money you will eventually leave to your beneficiaries.

Universal life does not benefit from dividend payments

While universal life does enable you to benefit from interest rates when they’re working in your favor (and lose value when they’re not), in general, you do not receive dividend payments from the insurance company.

How do they compare when it comes to premiums?

The money you pay-in every month to purchase your life insurance coverage is called your premium. In a whole life policy, this premium is a fixed payment of a set dollar amount. In a universal life insurance policy, you can raise or lower those payments as you see fit, within the limits of the policy.

Universal life provides more flexibility in payments

If you like choice, the universal life option allows you to adjust to your life circumstances. Having another child, or moving on to a different job, or one day taking out a loan to buy a business — all might be instances where a combination of protection and flexibility becomes important.

This type of policy might suit you if you’re envisioning significant income fluctuations or you think that you may want the ability to vary your payments.

Paying in less could eventually result in the need to pay higher premiums in later years to keep your coverage from lapsing. This option means that your premium payments could vary, providing flexibility to keep your policy in force your entire life.

Both whole and universal life insurance policies can be complex. Before deciding which type of life insurance policy is best for you, consider meeting with a financial professional to check out the options and discuss what best fits your needs.