Term vs. Universal Life Insurance: Comparing Coverage and Costs

Term vs. Universal Life Insurance At a Glance

Term life insurance is a temporary policy that provides coverage for anywhere between 10 and 30 years. On the other hand, universal life insurance provides coverage for a person’s entire life. It also comes with a savings or investment feature called the cash value. 

Term life and universal life insurance are two options to consider when shopping for life insurance. Each offers unique features and benefits for consumers. Read on to learn the difference between term and universal life insurance and which option makes the most sense for your needs.

Prepare For Your Loved One’s Needs

Life insurance plays a key role in providing financial security to American families. When a primary wage earner unexpectedly passes away, their loved ones may struggle to keep up with daily expenses and long-term financial goals. A life insurance policy’s death benefit helps cover these costs and ease financial strain.

Despite the importance of life insurance, 41% of Americans say they do not have enough coverage for their family’s needs. Purchasing a life insurance policy, whether term life, universal life, or another, helps fill this coverage gap. 

To prepare for your loved one’s needs, start by learning the difference between term and universal life insurance.

Term vs. Universal Life Insurance

	Term Life Insurance	Universal Life Insurance
Coverage Length	Set period, such as 10, 15, or 20 years	Lifelong coverage
Types	Options include level term, decreasing term, convertible term	Guaranteed universal life insurance, indexed universal life insurance, variable universal life insurance
Cost	Generally more affordable	Generally more expensive
Cash Value	No	Yes
Ideal Candidates	Need temporary coverage; do not need cash value	Need long-term coverage with cash value

How Term Life Insurance Works

Term life insurance offers temporary financial protection for a set period. Here’s how it works: You choose a coverage amount and term length. If you pass away during the term, the loved ones you named as beneficiaries receive the policy’s death benefit. The benefit is generally not taxable.

Consumers often purchase term life insurance with the goal of providing ongoing income replacement to their surviving loved ones. However, other reasons exist to buy a term life policy, such as funding education expenses for dependents or paying off the outstanding loans of the policyholder.

Common Types of Term Life Policies

• Level term: A policy that offers the same death benefit no matter when death occurs during the term. The premium also stays the same. 
• Decreasing term: A policy with a death benefit that steadily decreases over the length of the term, typically in line with a mortgage or other debt. Premiums decrease as the death benefit decreases.
• Convertible term: A policy that allows consumers to switch to permanent coverage without needing a medical exam or health questions.

How Universal Life Insurance Works

Universal life insurance offers coverage for a person’s entire life while providing more flexibility than other permanent life insurance policies. Here’s how it works: You choose a coverage amount and age when the coverage ends, which is generally 90 or older. When you pass away, your beneficiaries receive the death benefit.

Unlike term life insurance, universal life policies offer a cash value element. The cash value allows policyholders to save or invest money through their policy, which they can withdraw or borrow during their lifetime. 

Some consumers opt for universal life insurance if they want lifelong coverage to leave their loved ones an inheritance or funds for final expenses. Others use universal life insurance to reach long-term financial goals.

Common Types of Universal Life Insurance Policies

• Guaranteed universal life: A policy that offers a guaranteed death benefit and fixed premiums. It builds minimal cash value. 
• Indexed universal life: A policy that allows adjusting the death benefit and premiums. The cash value account is tied to a stock market index like the S&P 500.
• Variable universal life: A policy that lets consumers invest their cash value in the market through sub-accounts. The premiums are adjustable.

Coverage Length: Term vs. Universal

Term life differs from universal life in that it provides temporary coverage. Term life policies remain active for a set number of years, typically between 10 and 30. Universal life insurance offers coverage for a person’s entire life. 

Coverage length matters because a policyholder’s beneficiaries only receive a death benefit when the policy is in effect. When beneficiaries receive a death benefit, whether from a term life or a universal life policy, they generally do not owe tax on the payout. 

Cost: Term vs. Universal

Cost is a major difference between term and universal life insurance. Term life insurance tends to be lower cost because it only provides coverage for a predetermined number of years and does not include a cash value component. Universal life insurance is pricier because it combines lifelong coverage with a cash value.

Specific costs vary from person to person. As an example, for a healthy 50-year-old man, 20-year, $250,000 term life policies range from around $480 to $840 per year. For universal life insurance policies with the same coverage amount, costs range from around $2,550 to $4,750 per year. 

Cash Value: Term vs. Universal

Cash value is a component of universal life insurance, while term life insurance policies do not offer a cash value. Here’s how cash value works: When policyholders pay premiums, a portion of the money is deposited into a cash value account which grows over time. 

The cash value growth may be minimal in a guaranteed universal life policy. Indexed universal life insurance and variable universal life insurance offer the potential for higher cash value growth. 

Similar to retirement accounts, cash value accounts grow tax deferred. Consumers do not pay taxes on their earnings until they choose to withdraw money.

Pros and Cons to Consider: Term vs. Universal

Term life insurance and universal life insurance work very differently, but neither is necessarily better than the other. By weighing the pros and cons of each option, consumers can identify a policy that suits their needs.

Advantages and Drawbacks: Term Life Insurance

Term life insurance has several advantages over universal life insurance, including lower initial premiums and flexible policy terms. However, there are also some potential drawbacks of term life to consider, including the lack of cash value.

Pros

• Low initial premiums: Monthly premiums for a term life policy are typically at least five times less than a comparable universal life policy.
• Flexible policy terms: Policyholders choose the length of coverage they want, typically from 10 to 30 years.
• Easy to understand: Term life is the simplest type of life insurance, which appeals to first-time buyers.
• Fewer tax implications: Term life policies do not accumulate cash value that policyholders may need to report as income.

Cons

• Coverage has an end date: Term life policies offer temporary coverage that expires at the end of the term.
• High premiums at renewal: When consumers have the option to renew their expiring policy, the cost of premiums may be prohibitive.
• No cash value component: Unlike universal life insurance, term life policies do not build a cash value. It’s not possible to withdraw or borrow money from a term life policy.
• No surrender value: People who cancel their term life insurance coverage do not receive money back unless they add a return of premium rider.

Advantages and Drawbacks: Universal Life Insurance

Universal life insurance policies have some unique features that can make them more appealing than term life policies, including cash value and adjustable premiums. However, they also have potential drawbacks.

Pros

• Flexible premiums: Policyholders can typically raise, lower, or skip premium payments if their financial needs change. 
• Adjustable death benefit: Some universal life policies allow consumers to raise or lower their death benefit within certain limits. 
• Access to cash value: Universal life policies accumulate cash value for the policyholder’s future use. 
• Surrender value: When a consumer cancels their universal life insurance, they may get a lump-sum back, known as the surrender value. The amount varies.

Cons

• High premiums: Lifelong coverage comes at the cost of much higher premiums than comparable term life insurance policies.
• Risk of a policy lapse: Policies typically lapse when the cash value drops to zero, so it’s important to keep an eye on the cash value balance. 
• Returns are not guaranteed: Gains and losses are tied to an index or investment sub-account, so in a weak market, the cash value grows slowly or even shrinks.
• Potential tax implications: Policyholders who tap their cash value may pay income tax on the account’s earnings.

Choosing the Right Life Insurance Policy

Buying the right life insurance policy helps consumers support their loved ones or even make progress toward their long-term financial goals. To decide between term vs. universal life insurance, consider your specific circumstances.

What to Factor

• Assess your needs: Consider the income you might need to replace, your outstanding debts, and any long-term financial goals your family is working toward. Choose whether or not life insurance fits into your savings and investment strategy.
• Check your budget: Decide how much you can comfortably spend on monthly or annual premium payments. Think about how much your financial situation may change in the future and whether or not you may need flexible premiums.
• Evaluate your risk tolerance: Assess if a life insurance policy fits into your overall financial strategy and, if so, if you’re comfortable with the risk of low earnings or a reduction in the cash value.

Consider Term Life Insurance If…

• You want short-term coverage in place during your working years.
• You want to ensure your family can pay off debts if you pass away unexpectedly.
• You do not think you’ll need life insurance after your chosen term ends.
• You’re on a tight budget and cannot afford a permanent policy.
• You’re not interested in using life insurance as a savings or investment tool.
• You want a simple and straightforward life insurance product.

Consider Universal Life Insurance If…

• You need coverage that lasts for your entire life. 
• You want the option to raise or lower premiums if your financial situation changes.
• You want the option to modify the death benefit in the future.
• You’re interested in accumulating cash value for future use.
• You’re comfortable actively managing your investments in the case of variable universal life policies.
• You have a trusted agent to help you understand the complexities of universal life policies.

Putting It All Together

Life insurance helps Americans financially protect their loved ones if the unexpected occurs. Since everyone’s financial and family situation is different, insurance companies offer many types of policies to suit various needs.

For some consumers, a term life insurance policy is the right choice for their loved ones’ needs. For others, the lifelong coverage and cash value component mean a universal policy is more appropriate. Other people decide neither option suits their needs and look into alternatives like whole life insurance. For help choosing the right life insurance policy, speak with a trusted agent.