So, after much thought, you finally decided that you need permanent life insurance coverage. The next thing you need to settle is what type of policy is the best for you – is it whole life or universal life? From this takeoff point, you can dive into specific variations of each policy that suit your needs.
Prudent planning will teach you that it's not that one type of policy is better than the other and what works for one individual may not have the same impact on another. So, let's take a closer look at the basic traits of each type so you can gauge which policy might be the best for you.
Understand Permanent Life Insurance Policies
The two most common types of permanent life insurance policies are whole life and universal life. Identifying the major differences between the two can be pretty confusing. Since both provide a financial benefit to your beneficiaries upon your death, how do you choose what to buy? Some of the things you can ask: do they offer cash value that appreciates over time? Which one is less expensive? What are the basic differences between the two?
If you have been in the market for a life insurance, you have probably asked the same questions (and even more). We hope that by reading on, you can find some basic answers and get a better understanding of the differences between whole life and universal life insurance.
Whole life and universal life insurance both fall into the category of permanent policy. This signifies that they will remain in effect your entire life and will not expire after a certain period as long as you are paying the premiums. Both have the potential to accumulate cash value over time, the value that you can borrow against tax-free for any purpose. Keep in mind that this feature will normally drive the premiums higher than term insurance.
What is Whole Life Insurance?
A whole life insurance policy is characterized by having a fixed premium – you pay the same amount every year for your insurance coverage. Just like universal life insurance, whole life has the potential to accumulate cash value over a period of time. You can then borrow against the money that it has built up.
A whole life insurance policy provides life insurance protection but at the same time accumulates a cash value. It might be a good choice for you if you want a policy that has:
- Level premiums that stay the same amount for the life of the policy
- Cash value accumulation that you can use while you're still living
- Insurance protection that remains active as long as you pay the premiums on time
What is Universal Life Insurance?
Universal life insurance features flexible premiums that can allow you to determine how much you'll pay each year by making use of some of the policy's cash value. However, you will need to pay the minimum premium amount or the policy will lapse. If the accumulated cash value is big enough, the insurance company can use it to cover the premium or just let stand to grow bigger over time (See how to choose a life insurance company).
The specifics of each individual policy plus some other factors will determine the potential growth in a universal life policy. When you buy a policy, the insurance company will establish a minimum interest crediting rate; you'll see this specified in the contract. In the case where the insurer's portfolio earns more than the minimum interest rate, the insurer may add the excess interest to your policy. For this reason, universal life policies have the potential to earn more than a whole life policy in many years, while in others they can earn less.
You should go for a universal life insurance policy if you want:
- Flexibility to adjust your premiums and coverage amounts
- Cash value that you can borrow from as long as you're still alive
- A permanent life insurance protection and access to cash values
Benefits of Universal Life Insurance
Universal life is quite flexible because it offers a variety of different payment options, recourse to change death benefits and alternative to store up cash value over time. Here's how:
- If the cash value component has already grown and is enough to cover the required expenses for the month, you may already skip out-of-pocket payment of the premium
- Some policies will give you the option to modify your death benefits to be more appropriate to your personal circumstances
- In many cases, you have the privilege of borrowing against the cash value that you have built up in the policy
The interest that you earn over time accumulates on a tax-deferred status.
Benefits of Whole Life Insurance
A whole life insurance is pretty inflexible because you basically pay a fixed premium that won't increase, the potential to accumulate cash value over time and a pre-determined death benefit for the duration of the policy. Add to that:
- Cash value growth is tax-deferred (same with universal life)
- The privilege to make withdrawals and loans against the policy
- The ease of budgeting since you will already know from the beginning the monthly premium payment that you have to make.
Key Differences Between Whole Life And Universal Life Insurance
If you were to choose just one difference that a universal life policy has over a whole life policy, it would have to be flexibility.
Although whole life insurance guarantees your returns, your earnings from a universal life insurance policy will depend highly on the market and current interest rates. If your universal life insurance policy does incredibly well, you can have significant increments in your cash value. However, a bad performance may end up to your loss of the cash value.
The primary advantage of a universal life insurance policy is its convenient flexibility. For example, if you want to stop paying premiums for a period of time, it is acceptable. However, there is a potential loss of the value of your policy. Optionally, you may use your cash earnings as direct premium payments – this is on the condition that you have enough balance built up into your account. You can also decide to adjust the number of your premium payments or borrow against your policy if you're cash-strapped. Regulations mandate that your insurance company disclose the entire cost of your universal life insurance policy to you. This will ensure that you always have a clear picture of how your policy is performing.
The next key difference is the manner of paying interest. In universal life insurance, the company adjusts the interest payment monthly; while on a whole life insurance policy, they adjust it annually. This would affect the cash values of the two different types of policy on certain occasions.
During periods of rising interest rates, universal life insurance policyholders would experience a rapid increase in their cash values compared to those with whole life insurance policies.
3. Cash Value
The company guarantees cash values in whole life
Needless to say, the cash value amount that you are storing up is a valuable financial asset and it's one that you can use during your lifetime. Should you need money, you can borrow and/or withdraw from it – to supplement your retirement income, help pay for college tuition and many other needs. Your cash value grows according to the interest rate guaranteed by the insurance company. Plus, additional growth coming from non-guaranteed dividends.
Dividends are what you get as your share of the company's profits being a policyholder. If you give it sufficient time, it can grow the cash value portion materially. Keep in mind though, that loans and withdrawals you make from your policy will lessen the amount of money you will leave to your beneficiaries.
Universal life cash values and premiums can fluctuate
In a universal life insurance policy, the growth of the cash value will depend primarily on the interest rates associated with the specific type of policy. Variable, indexed or current assumption universal life policies will have different growth patterns. How much premium you pay and how much early use of the cash value you make will also affect the overall growth.
There is some risk that comes with universal life primarily. Because of the impact on the cash value of crediting interest rates, cost of insurance rates, and of course, the general investment performance. It could also turn out the universal life policy becomes underfunded, which means that the total amount of premiums collected are less than the current charges. The company then deducts the difference from the cash value. Depending upon the provisions of the contract, if the cash value goes down to a certain point, the policy will lapse.
Whole life can also benefit from dividend payments
When you purchase a whole life policy from a mutual insurance company, you may receive annual dividends. Of course, a lot of it will depend on the profitability of the insurance company for that specific year; it is not really guaranteed.
However, there are mutual companies that have a solid track record of releasing dividend payments practically every year. You can use these dividends to buy additional insurance on your current policy. You can also use it to grow your death benefit and cash value altogether. Also, you can use the dividends and additional coverage they purchase to take care of all or a portion of your future premiums. Other available options are to receive the dividends in cash each year or just allow them to collect within the policy for future use.
Universal life does not benefit from dividend payments
Sure, universal life gives you an advantage when it comes to interest rates when the market is swinging in your favor but lose value when they go the other way. But as a rule, you will not receive dividend payments from the insurance company.
How To Find The Right Policy For You
It may be that whole and universal life policies have their own sets of unique features and benefits. They both focus on making available funds for your family when you die. Our suggestion is that you work with a qualified life insurance agent or company representative. With their help, you will be able to find and choose a policy that will best meet your individual needs, budget and specific financial objectives.