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By José Omar Rodríguez
October 23, 2020
Money; Getty Images

There are two main options for people looking for life insurance: term life insurance and permanent life insurance. Term life, the most popular and affordable­ of the two, refers to policies that guarantee a fixed death benefit payout for named beneficiaries if the insured dies before the policy’s “term” expires — usually between 10 and 30 years. It’s a simple, straightforward policy that requires no active participation from policyholders, other than, of course, making the premium payments as agreed.

Permanent life insurance, on the other hand, allows for coverage that does not expire. Instead of renewing a policy every 10, 20, or 30 years, permanent life lets policyholders keep their coverage for a lifetime.

Term vs. Permanent Life Insurance
Term: Permanent:
Expires after a certain period (10, 20, 30 years) Does not expire
Benefits only upon death Benefits available before death
No investment or savings component Includes a savings or investment component
Lower premiums Higher premiums
Cannot be surrendered Can be surrendered

There are two life insurance products under the permanent life umbrella: whole life insurance and universal life insurance. Both options are very similar in that they offer “lifetime” coverage and have a savings or investment component called the “cash value.”

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The main difference between these two insurance products has to do with flexibility, specifically regarding premium payments, cash accrual and allocation, and coverage amount. In short, how much control you have over your policy.

Of the two, whole life insurance is the least flexible option; it features fixed premiums, a set benefit amount, and guaranteed cash value accumulation. That means whole life policies have appealing guarantees, but they don’t allow policyholders to have much control over their coverage once it begins. Because the cash value component’s rate of return is guaranteed, whole life insurance products are more stable and, therefore, costlier. These may be better suited for individuals with lower risk tolerance and more disposable income.

Whole vs. Universal Life Insurance
Whole Life: Universal Life:
Guaranteed rate of return Cash return based on market rates
Allows for little flexibility Very flexible terms
Higher premiums Lower premiums
Coverage and benefits cannot be updated Coverage and benefits can be updated
Fixed premiums Flexible premiums

Universal Life Insurance Options

Universal life insurance is a type of permanent life insurance coverage consisting of two parts: an investment account and a death benefit. While these components are also present in whole life insurance, what makes universal insurance stand out is the flexibility policyholders have regarding managing their policies, especially their premiums.

Premium payments for universal life policies go toward funding the death benefit first and then to the policy’s savings or investment account. Like a traditional savings account, this investment portion of a universal life policy will accumulate cash value based on current stock market rates or an established minimum rate of return.

The tax-deferred interest accrued in the investment component, also known as “cash value,” can be accessed and used by policyholders in several ways:

It can be used to cover the cost of insurance in whole or in part. This is one of the main selling points of universal life insurance, as the policy “pays for itself” if enough excess cash accrues.

You can make partial withdrawals from the policy’s cash value. However, there are different tax treatments depending on whether you withdraw from the basis (what you paid into it) or the excess cash (what accrues over time). While borrowing from the former is tax-free, money borrowed from the latter is taxed.

You can also take a loan from the policy’s savings account. One of the big advantages of this type of loan is that your credit score will not be affected whether you pay it or not. However, unlike traditional loans, loans taken from a policy’s cash value require that you make interest payments to the insurance company; otherwise, the amount owed will be deducted from the remaining cash value and, if that amount proves insufficient to cover interests, the policy will lapse.

The other main distinguishing feature of universal life insurance is that it allows for changes in the death coverage itself. At any time, and subject to the policy’s terms and conditions, a policyholder may decide to increase or decrease the amount of coverage without having to purchase a new policy. When this happens, the premium payments will be changed accordingly. This is a great tool for some people, as it lets the insured determine how much coverage they need at a particular point in time.

To recap, the benefits of universal life insurance include:

  • Lifetime coverage with an investment account
  • Premiums, coverage, and benefits can be changed at any time
  • Cash accrual based on market rates
  • Can be surrendered (fees will most likely apply)
  • Allows for loans and withdrawals of cash value
  • Excess cash from investment account is tax-deferred and can be used to pay for premiums

Types of Universal Life Insurance Policies

Universal life insurance is itself an umbrella term encompassing four different products:

  • Traditional universal life – The most basic of all the four options. Interest rates are not guaranteed, as they are based on current market fluctuations. This means that, while your account may grow exponentially during strong economic times, it may also decrease to the point where the cash value is not enough to pay for the coverage, causing the policy to lapse.
  • Indexed universal life – Allows policyholders to allocate their cash value in a fixed account and/or an equity-indexed account such as Nasdaq-100 and S&P-500. This gives policyholders more control over their policies but also makes it a riskier option than traditional universal life insurance.
  • Variable universal life – The riskier of all universal life insurance products, lets policyholders invest their cash value in bonds, stocks, and mutual funds. It’s the most flexible of all the options but requires hands-on management.
  • Guaranteed universal life – Allows for premiums, benefits, and coverage that will not change over time. It offers the lifetime protection of permanent life insurance along with the stability of term life. One downside, since it involves very little risk, its investment account accrues little cash value.

How Benefits are Paid

While universal life insurance is considered “permanent,” meaning it’s supposed to last throughout the insured’s lifetime, the reality is that these policies have a “maturity date,” typically between ages 85 and 121.

If the person is still alive upon reaching the maturity date — which is less unusual with each passing year, as more and more people are living to be over 100 years — the insured will receive a payment according to the policy’s terms.

If the person dies before the policy’s maturity date, the amount the beneficiaries receive will depend on the policy’s death benefit type, of which there are two: level death benefit and increasing death benefit.

The most common and affordable of the two is level death, in which beneficiaries only receive the policy’s face value while the insurer keeps the accrued cash value.

On the other hand, a policy with increasing death benefits will pay beneficiaries both the death benefit and the cash value. Because it’s supposed to pay more, this type of policy features higher premiums than ones that provide level death benefits.

Lastly, you should know that, before the insurance company pays the benefits, it will deduct any pending premium payments and/or debts related to loans or cash withdrawals.

Pros and Cons of Universal Life Insurance

The main selling points of universal life insurance — its flexibility and ability to incur more risk — are its biggest downsides for many policyholders. In fact, if you want a simple life insurance policy that only requires you to make premium payments, universal life insurance might not be for you.

According to Elaine Tumicki, director of life insurance product research at LIMRA, universal life insurance “requires more responsibility from the consumer to manage the product. With others, you know what the premiums are, but universal life, because of the flexibility it allows, must be monitored closely and regularly.”

Because costs of insurance rise as you age and returns are unpredictable — and much lower than they were in the 1980s, when universal insurance was created — you may find that the cash value in your account is not sufficient for covering a rising cost of insurance. If this happens, you’ll have one of two options, none of which are good: pay higher premiums to cover the cost of coverage or let the policy lapse. In fact, many universal life policyholders have seen their premiums double and even triple because of this.

What’s more, even if there is enough cash value in the policy to cover the cost of insurance, you may find that the accrued cash is significantly lower than you expected if you don’t keep an eye on your returns. Discovering that years of investing have amounted to nothing would be a worst-case scenario.

Below, you’ll find the biggest advantages and disadvantages of universal life insurance:

Pros and Cons of Universal Life Insurance

For many policyholders, the main selling points of universal life insurance — its flexibility and ability to incur more risk — are its biggest downsides. In fact, if you want a simple life insurance policy that only requires you to make premium payments, universal life insurance might not be for you.

According to Elaine Tumicki, director of life insurance product research at LIMRA, universal life insurance “requires more responsibility from the consumer to manage the product. With others, you know what the premiums are, but universal life, because of the flexibility it allows, must be monitored closely and regularly.”

Because costs of insurance rise as you age and returns are unpredictable — and much lower than they were in the 1980s, when universal insurance was created — you may find that the cash value in your account is not sufficient for covering a rising cost of insurance. If this happens, you’ll have one of two options, none of which are good: pay higher premiums to cover the cost of coverage or let the policy lapse. In fact, many universal life policyholders have seen their premiums double and even triple because of this.

What’s more, even if your policy’s cash value is enough to cover the cost of insurance, if you’re not consistently watching your returns, you may find that the accrued cash is significantly lower than you expected. This is a worst-case scenario, as you discover that years of investing have amounted to nothing.

Below, you’ll find the biggest advantages and disadvantages of universal life insurance:

The Pros and Cons of Universal Life Insurance
Pros Cons
If market rates go up, so will your cash value. If market rates go down, there will be little to no cash value accumulation.
You can access the cash value through withdrawals or loans without the risk of damaging your credit. If you intended the policy to pay for itself, but there isn’t enough cash value in the account, the policy will lapse unless you pay the premiums out of pocket.
The interest your account generates is tax-deferred. Premiums are considerably higher than for other types of life insurance, such as term life.
You can change premium payments, death benefit amounts, and coverage amounts at any time. You have to actively manage and monitor your policy.

FAQs About Universal Life Insurance

What are the risks of purchasing a universal life insurance policy?

The risk associated with universal life insurance is related to the policy’s cash value component being invested in the stock market. Unlike whole life insurance, most universal life policies don’t come with guarantees — with the exception of guaranteed universal life. That means your policy’s cash value accumulation will depend on the performance of the market. If the cash value account fails to accrue enough funds to pay your premiums and you cannot afford them out of pocket, your policy will lapse and you’ll lose your investment.

Another risk factor involves steering practices in the insurance industry. Some insurance agents, for example, receive higher commissions for selling permanent life insurance. This may lead agents to try to sell policies that may not be the best for their clients’ needs and budgets. If you’re unsure about which type of life insurance policy to buy, consider speaking with a financial advisor or certified financial planner who can look at your finances and goals to develop a plan that works for you and your loved ones.

In general, cash value life insurance is an option for those who can afford higher premium payments and have exhausted other investment options, such as IRA, Roth IRA, and 401k accounts. If you have dependents but your financial situation is uncomplicated, meaning you only need life insurance for your dependents for a specified period, term life insurance can be the most fitting and affordable option with high coverage amounts.

What factors determine my premium payments?

Your life insurance premiums will depend on your age, health history, gender, occupation, habits (whether you’re a smoker non-smoker or practice high-risk hobbies), the life insurance plan you choose, and the coverage amount you wish to purchase.

Life insurers have different underwriting guidelines, which means they all price risk differently. To get the lowest possible premium, shop around and get quotes from different life insurance companies.

Universal Life Insurance in a Nutshell

Universal life insurance may be right for you if three conditions are met: 1) you want coverage that lasts a lifetime; 2) you are willing to put in the work of managing and monitoring your policy’s investment account, and; 3) you understand the risks involved.

We strongly recommend that you consult an insurance professional before you purchase a life insurance policy. Ask any questions you may have, and don’t commit until you’ve found the right policy and insurer for your needs.

More from Money:

A Guide to Term Life Insurance

A Guide to Whole Life Insurance

Best Life Insurance Companies of 2020

Advertiser Disclosure

The purpose of this disclosure is to explain how we make money without charging you for our content.

Our mission is to help people at any stage of life make smart financial decisions through research, reporting, reviews, recommendations, and tools.

Earning your trust is essential to our success, and we believe transparency is critical to creating that trust. To that end, you should know that many or all of the companies featured here are partners who advertise with us.

Our content is free because our partners pay us a referral fee if you click on links or call any of the phone numbers on our site. If you choose to interact with the content on our site, we will likely receive compensation. If you don't, we will not be compensated. Ultimately the choice is yours.

Opinions are our own and our editors and staff writers are instructed to maintain editorial integrity, but compensation along with in-depth research will determine where, how, and in what order they appear on the page.

To find out more about our editorial process and how we make money, click here.

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