Life insurance provides financial aid to your beneficiaries and dependents when you die. There are two major types of life insurance: term insurance and permanent insurance.
Term insurance is an affordable option and provides a death benefit, but often doesn’t provide lifetime coverage. Permanent insurance provides a death benefit and lifetime protection, as well as a cash value component. With permanent insurance, the policyholder can accumulate a cash value that is accessible during the insured’s lifetime.
When it comes to permanent life insurance, there are two main types: whole life and universal life. Each has its own set of strengths and weaknesses. When it comes to universal life policies, an indexed option may give the policyholder holder a larger growth of their cash value account.
Whole Life vs. Universal Life Insurance At a Glance
Whole life and universal life policies both provide death benefits, tax deferments, and cash value accumulation.
With whole life policies, the premiums and death benefits do not fluctuate, and the cash value growth is guaranteed at a minimum rate. This is ideal for people who prefer a low-risk option and a set death benefit amount.
Universal life provides the policyholder with added flexibility. The premiums are not fixed, and the death benefit is adjustable. However, the cash value accumulation could be based on market trends and can be risky.
| Insurance Policy Information | Universal Life Insurance | Whole Life Insurance |
| Premium | Flexible | Fixed |
| Cash Value | Larger risk | Guaranteed growth |
| Death Benefit | Flexible | Fixed |
| Dividends | No | Usually; depends on the company |
| Frequent reviews required? | Yes; preferable | No |
Understanding Universal Life Insurance
Universal Life (UL) Insurance allows the policyholder the flexibility of adjusting their premiums and death benefits as needed. UL policies have two parts—the death benefit itself and the built-in cash value account.
In an indexed universal life, the cash value earns interest based on the current rate of the index it’s linked to such as the S&P 500. Since the cash value’s interest isn’t fixed, there is a level of risk involved for the policyholder. For example, if the market’s performance is poor, the policyholder’s cash value may not increase.
If the policyholder chooses a universal life policy that is not linked to an indexed account, they can expect their cash value to grow based on a fixed rate set by the life insurance company. However, not all companies provide a minimum interest rate and, if they do, the fixed rate is usually much lower than what can be earned in an indexed account.
With universal life, the premiums are not fixed, so the policyholder can pay more than the minimum amount. The remainder of the premium payment goes into the cash value account. There is also an option to have the cash value, once it’s accumulated to a certain amount, to pay the insurance premiums, so the policyholder doesn’t have to pay out-of-pocket. On the other hand, if the policyholder does not pay enough premium into the policy, the policy may become underfunded and lapse.
Advantages of Universal Life Insurance
Limited Tax Implications
Under most circumstances, universal life policyholders can borrow against their cash value without tax implications. This is an excellent option if the insured needs some quick cash for an emergency. However, the policyholder should keep in mind that the loan will need to be repaid or it will accrue interest that will be added to the loan. Should a policyholder surrender their policy before the loan is repaid, the loan amount may then become taxable.
Flexible Death Benefit
As you age, the cost-of-living increases. In other words, your initial death benefit amount might need to be increased to have the same spending power for your beneficiaries. Unlike the fixed death benefit of a whole insurance policy, with universal life, you can increase your death benefit amount to better suit your needs.
Savings Opportunities
With some universal life insurance policies, the policyholder’s cash value is earned by the interest made on a linked index account. Since cash value is accumulated as premiums are paid, this means that the more that is paid into the policy, the more interest can be earned. How much the policyholder can pay into the policy, will vary depending on that specific policy.
Disadvantages of Universal Life Insurance
No Dividend Payments
Many whole life insurance policies pay out dividends to their policyholders. With universal life, you can benefit from interest rates in favorable conditions as a tradeoff to dividend disbursements.
Active Participation
With universal life, the policyholder must monitor the cash value closely and adjust premiums as necessary. If not, the policy could become underfunded and possibly lapse.
Higher cost
Since the cash value of a universal life policy is linked to an indexed account, there are added policy charges and management fees.
Understanding Whole Life Insurance
Whole life insurance provides the policyholder with the dependability of a guaranteed premium, death benefit, and cash value accumulation rate.
The cash value of a whole life policy accumulates at a fixed rate. Since the rate of return is guaranteed, whole life policyholders will pay higher premiums than universal life policies. The higher premiums are a tradeoff for the security that comes with guaranteed rates.
Advantages of Whole Life Insurance
Cash Value
With a whole life policy, cash value accumulates at a fixed rate. Unlike with universal life, where the accumulation rate is dictated by other factors.
Potential Dividends
Depending on the insurance company, some whole life policies pay out dividends. These can be used to self-fund policy premiums or to purchase additional insurance.
Fixed Premiums
With a whole life policy, the amount you pay for the coverage remains static for the life of the policy. With universal life, the premiums can increase over time for many reasons.
Disadvantages of Whole Life Insurance
Higher Premiums
With a whole life policy, premiums are more expensive than a universal life policy. The cash value accumulation rate with a whole life policy is guaranteed. A universal policy’s accumulation rate fluctuates with the market and may actually be higher than that of a whole life policy, but is not guaranteed. Whole life premium’s steadier cash value growth rate means fewer unknowns and an overall more expensive premium.
Lack of Flexibility
Whole life policies lock the policyholder into a fixed death benefit amount and doesn’t allow for increases for cost of living. For example, a whole life policy with a death benefit of $200,000 won’t have the same spending power in 40 years.
Less Interest
Whole life doesn’t have the same risk factor as universal life, but the safety of fixed cash accumulation rates means you may earn less interest over the lifetime of the policy.
What to Consider When Choosing Universal vs. Whole Life Insurance
When it’s time to decide on whether a whole life policy or universal life policy is right for you, there are some things to consider.