Term vs. Universal Life Insurance: What You Need to Know

Term life and universal life insurance benefit your beneficiaries if you die during the duration of coverage. While they are both life insurance and offer some of the same protections and peace of mind, there are many differences.

One of the most significant differences is that term life insurance lasts for a specific period or term; universal life lasts until death. Term coverage is a more straightforward approach and is often considerably less expensive.

Universal life insurance lasts throughout your life and has a built-in savings component or a cash benefit that grows over time.

What Is Term Life Insurance and How Does It Work?

Term life insurance is the most basic life insurance you can get. Most term policies last 10, 20, or 30 years and then expire. Some renewable term policies allow you to renew or extend your policy.

Term life insurance is often a benefit that an employer offers. If you can get term life as an employee benefit, the term usually lasts until you no longer have that job.

Your term payments feature the same fixed premium rate and tend to have the lowest rate. If you outlive your term, the policy is over unless you have a renewable term policy. While you no longer need to pay, your beneficiaries no longer have financial protection should you die during the lapse.

If you die while your term life insurance plan is in effect, your beneficiaries will receive the death benefit amount.

Types of Term Life Insurance

Some term life insurance policies have been adapted to add other features to make them more flexible, versatile, and appealing if you want more coverage but can’t afford whole or universal life insurance policies.

Level Term Policies

Level-term life insurance is the most basic form. The word level references your premiums and death benefits and the fact that they stay the same throughout the entire policy.

Convertible Term Policies

Convertible term policies let you trade your term life insurance for permanent coverage. The permanent insurance will take over the term policy and last as long as you live. Other benefits come with this change in insurance also. One thing to note is that converting term life insurance to permanent life insurance will typically involve a higher premium.

Decreasing Term Policies

Decreasing term life insurance is often used to cover a specific debt, usually a mortgage. For example, suppose you take out a 30-year mortgage and a 30-year decreasing term life insurance policy. In that case, the amount you owe on the mortgage generally keeps pace with the life insurance benefit your beneficiary will receive upon your death. The primary goal is to ensure your family or dependents can keep the house, and the insurance policy will give them enough to pay off the mortgage.

Return of Premium (ROP) Policies

A return of premium policy is a life insurance policy that offers a death benefit to your named beneficiaries. If you outlive the policy term, you will have the premiums you paid to the insurance plan returned. The downsides to this type of policy are that they’re more expensive than regular term life insurance. Also, an ROP does not give you any interest; it only returns the amount you paid – meaning you could make more in a different type of savings account. The benefit is you have that peace of mind that comes with life insurance, and if you outlive the policy, it costs you nothing.

Yearly Renewable Term (YRT) Policies

A YRT policy provides one-year renewable coverage. The catch is that the rate will be reevaluated each year and will most likely go up simply because you’ve aged another year.

What Is Universal Life Insurance and How Does It Work?

Universal life insurance falls into the category of a permanent policy, and it lasts until your death. In addition to covering you for life, there are a few other differences between universal and term.

Universal life insurance has a cash value that works like a savings account, building up over time on a tax-deferred basis. The way you can access this cash value depends on your specific policy.

While you can cancel term insurance anytime, universal life often has penalties for canceling yearly. Insurance providers structure premiums so that the initial payments go toward the savings component and the later payments contribute toward the policy. This diffused payment schedule is why there may be penalties for early forfeiture.

Types of Universal Life Insurance

Like term life insurance, universal life features variations affect how much you pay, how you pay, and what your benefits are. Some of the most common are:

Traditional or Non-Guaranteed Universal Life Insurance

A traditional universal life insurance policy might also be called a non-guaranteed policy. It’s a straightforward universal life policy with a cash value savings account, flexible premiums, and a death benefit. If you ever want to change that policy, you can not change it unless it lapses.

Guaranteed Universal Life Insurance (GUL)

A guaranteed universal life insurance plan is for you if you want to ensure the policy can not lapse. GUL gives you cash value savings, flexible premiums, and death benefits. You’ll have a set minimum premium you must pay, and then your coverage can’t lapse.

Indexed Universal Life Insurance (IUL)

An indexed universal life insurance policy is good if you like the investment concept. An IUL places your cash in a market index fund. Because your provider invests in the payments, the value typically grows faster. The effect is similar to how stocks may show a greater rate of return than a traditional saving account. Policies have different guaranteed rates of return, and the fund needs to meet the target premiums, or the plan could lapse. Unfortunately, the policy can get complicated and might require a financial advisor.

Variable Universal Like Insurance (VUL)

A variable universal life insurance policy is similar to an IUL policy because the cash value can grow more rapidly through investments. The main difference is that a VUL policy allows you to diversify your investments with a mix of stocks, indexes, and money market accounts. It’s for someone who is more skilled in investing and will spend some time tending the account.

Term vs. Universal Life Insurance Coverage Comparison

Insurers designed term and universal life insurance to pay your beneficiaries a set amount in the event of your death, as long as you have a policy. Beyond that, there are more differences between the two policies than similarities.

When it comes to coverage, a term policy only lasts as long as the term. If that term expires and you’ve outlived its length, there is no death benefit, the insurance ends, and you get no refunds or cash back.

Insurers design universal policies to last throughout your lifetime, giving your beneficiaries a guaranteed tax-free death benefit. Universal life also has a cost savings feature for your beneficiaries upon your death, or you may be able to use it during your lifetime differently depending on the type of universal life you choose.

Term vs. Universal Life Insurance Cost Comparison

When it comes to cost, term life insurance is much less expensive. Because there’s a limit to the coverage term, all of the premiums are lost if it isn’t used within that period – unless you have an ROP policy.

Universal life, however, will pay out at some point to your beneficiaries, so the premium costs are higher. The cash value portion of universal life also adds to the cost of having this type of life insurance.

A term policy might be the best option if you do not have extra income but want life insurance security. If you are more interested in a long-term policy that has an investment component, then universal life is the way to go. Think of it this way, a term life insurance policy will not benefit the policyholder. A universal life insurance policy benefits the policyholder and beneficiaries.

Term vs. Universal Life Insurance Pros and Cons

The length and cost of coverage are very different for these two policy types, and they’re the most common factors people cite for making life insurance choices. But the idea of accumulating cash value can also be a significant factor in deciding to select universal life over term life.

Term Life Insurance Pros

Term life insurance has several benefits, and if it’s a free benefit through work, that’s often the biggest reason to opt into a plan. You can always add other insurance plans if you feel it’s a good idea. Here are several reasons why:

• Term Life is more affordable than other options. You might be a free policy through work.
• You can cancel your policy at any time without a penalty.
• The policy and coverage are simple and easy to understand.
• Term life often can be converted into a permanent life policy.

Term Life Insurance Cons

While term life insurance is affordable and offers peace of mind to some people who usually would not purchase life insurance, there are also some downsides to this type of policy:

• Term life utilizes a “use it or lose it” approach to life insurance.
• The policy is a temporary benefit.
• There are no savings or cash value options associated with this option.
• Term life features escalating premiums, depending on the policy.

Universal Life Insurance Pros

Universal life insurance falls into the permanent life insurance category, ensuring that there will be a benefit to your beneficiaries. The permanency of this option is one of several positive aspects of this type of policy. Here are several more reasons:

• Universal life offers flexible premiums at any time in any amount, albeit with some limitations.
• You can change to a flexible death benefit during the policy.
• You can use cash value savings to pay premiums.
• Universal life offers investment possibilities, depending on the policy.
• This policy guarantees the beneficiary a payout.

Universal Life Insurance Cons

Universal life also has some downfalls that can make it a less appealing option:

• Universal life requires higher premium rates
• You must monitor your policy’s cash value or risk a policy lapse.
• There is an increased risk when returns depend on the strength of the market.
• Changing the policy could result in much higher premiums.

Choosing Between Term vs. Universal Life Insurance

Choosing a term or universal life insurance depends on your current financial situation and your approach to your financial future. Generally, younger people with new families or at the beginning of their careers find the price tag of a term life insurance policy much more appealing.

Term life insurance is also easier to manage. As long as you’re paying the premiums on time, you’re set and don’t have anything else to worry about.

Universal life is more expensive, so having extra funds to pay the premiums is essential. With that added expense comes a cash value element and savings. You can use the accounts to pay the premiums if you’d like. However, staying on top of your premiums and minimum balances is essential. If you do not, you face a potential policy lapse, resulting in cancelation and higher rates to reinstate.