Whole vs Universal Life Insurance
If you’re shopping for permanent life insurance, whole life insurance and universal life insurance are the most common options.
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What is whole life insurance?
Whole life insurance is the most common and least complex type of permanent life insurance. Whole life insurance will stay in place your entire life regardless of your health and the premium amounts are fixed and won’t change.
In addition to lifelong coverage, whole life insurance comes with a savings component that accrues cash value. Some whole life insurance policies also earn dividends. These policies are called participating whole life insurance.
Participating Whole Life Insurance
Participating whole life insurance policies have slightly higher premiums than non-participating whole life insurance policies. This is because the insurance companies have an intent to return part of the premium in the form of dividends. However, dividend amounts cannot be guaranteed.
Whole life insurance dividends can be:
- Received as cash
- Used to reduce your premium payments
- Used to buy fully paid-up insurance
- Left with the insurance company to earn interest (like a savings account)
- Used to buy term life insurance
- Used to overpay premiums and make your policy paid-up faster
What is universal life insurance?
Universal life (UL) insurance is another common type of permanent life insurance. It trades some of the value growth benefits of a whole life insurance policy in exchange for more flexible payment plans and a lower price.
However, while a whole life policy offers dividends that can grow above and beyond a normal interest rate, a universal life policy will only pay a set amount of interest each year. This means that between a universal life policy and a whole life policy purchased at the same time, the whole life policy will often grow faster and offer a greater death benefit.
Flexible Universal Life Premiums
Nearly every universal life insurance policy comes with a target premium amount. This is the amount that, if paid at regular intervals, would be enough to keep the policy active until it’s fully mature (typically age 121). This target premium is only a suggestion and the policyowner is not actually required to pay this amount.
During the first year of the policy, you choose whether to pay premiums monthly, quarterly, or annually (like you would any other life insurance policy). After the first year, you can decide if you want to keep paying regularly, change the amount you pay, or even stop paying the premiums altogether. If regular payments aren’t made, the policy is paid for and kept active by drawing on the cash value for its premium payments.
This does not mean that after the first year your universal life insurance policy is free. If the policy’s cash value ever drops too low, the policy will terminate. It’s important to pay close attention to your universal life insurance policy if you want to take advantage of the flexible premium payments.
Some people who own universal life insurance policies purchase them as plans they can pay for up front and just keep an eye on in the future. This allows for maximum investment earning potential.
If you choose to only pay the minimum amount required to keep the policy active, your premiums can increase as you age. A universal life insurance policy does not guarantee fixed premium rates like whole life insurance.
Indexed Universal Life Insurance
Indexed universal life insurance policies (IUL) have the normal features of traditional universal life insurance, but, with an IUL, your cash value is linked to the performance of a specific stock index, such as the S&P 500.
The premiums for an IUL are typically lower than those for whole life because you, the policyowner, bear the risk of the policy being tied to stock market performance versus the insurance company promising fixed interest rates. You also bear the burden of monitoring your policy’s performance to ensure the premium you’re paying is enough to cover its costs.
That being said, if you’re financially secure and have maxed out your 401(K) and IRA contributions, an indexed universal life insurance policy can be a very beneficial product to add to your financial portfolio. If you’re looking for a product to supplement your retirement income, an IUL is often chosen over whole life because of the growth potential.
Indexed Universal Life Insurance Premiums
With whole life insurance, your premiums are fixed throughout the life of the policy. This is nice for individuals who want a permanent policy that’s easy to manage. However, this also means that your premium dollars are evenly distributed between the actual cost of insurance and cash value. So, in your younger years, when life insurance should theoretically cost less, you’re paying the same amount as you would when you’re 65 years old, for example.
With indexed universal life insurance, the premium structure is unbundled (unlike whole life insurance). This means that the cost of insurance when you’re younger is cheaper so more of your premium dollars are accumulating compounding interest and growing the cash value faster than a whole life insurance policy.
Indexed Universal Life Insurance Policy Loans
There are IUL policies that allow you to take out policy loans while still earning interest on the amount. These are called participating loans.
You have an indexed universal life insurance policy that offers participating loans.
You have $100,000 in cash value and take out a $20,000 policy loan. The full $100,000 still earns interest. The $20,000 loan accrues interest, but also has the potential to earn interest.
Let’s say the year you take out the loan, your account is earning 10% interest and the cost of the loan is 4% interest. Therefore, your cash value is earning 10% and your loan amount is earning 6% through a transaction called positive arbitrage (credited interest minus the loan cost).
IUL policies are tied to the stock market and not every year results in growth. There may be years in which you earn nothing, but still are paying the loan interest.
There are also fixed loans and “wash” loans. Fixed loans have set interest rates and the loan is not credited. This loan is less risky but the cash value grows slower. Wash loans are set up so your credited interest rate is the same as the interest being charged on the loan, essentially making the loan zero-cost.
Just as with any other life insurance policy loan, an IUL policy needs to be paid back while you’re alive or the balance will be taken from the death benefit before being paid to your beneficiaries. If you decide to terminate the policy, the loan balance is taken from the cash surrender value before you’re paid out.
Using Indexed Universal Life Insurance for Retirement
Individuals looking for life insurance options to supplement their retirement income will often go with an indexed universal life insurance policy.
In your later years, taking out a tax-free policy loan is one way to accomplish specific goals or take advantage of opportunities you otherwise may not have been able to.
The following are common reasons why people borrow against their indexed universal life insurance policies:
- Acquire investment property
- Pay for a child’s wedding
- Contribute capital to a business venture
- Send grandchildren to college
- Retirement supplement
In retirement, it’s not uncommon for IUL policyowners to take loans from their policy or partial withdrawals and use that cash as retirement income. Loans are received tax-free, unlike funds withdrawn from a traditional IRA. In addition, you aren’t penalized for accessing the IUL’s cash value before you turn 59 ½.
Even if you use your IUL’s cash value account during retirement, don’t forget there is still the death benefit. As with any other life insurance policy, if you die while an indexed universal life insurance policy is inforce, your beneficiaries still receive the death benefit amount. Any outstanding policy loan balance will be taken from the death benefit before being paid out, and withdrawals permanently reduce the death benefit amount.
Guaranteed Universal Life Insurance
Guaranteed universal life insurance is a type of universal life insurance (permanent coverage) with less bells and whistles and, therefore, costs less. One way of looking at a guaranteed universal plan is to think of it as a term life insurance policy that lasts your lifetime. Guaranteed universal life insurance may be ideal for individuals who want lifelong death benefit protection, but don’t need the fancy extras other permanent products offer, such as cash value.
Quotacy works with a few insurance companies that offer guaranteed universal life insurance. To learn more about this product, head to this article: What Is Guaranteed Universal Life Insurance?
Questions? Talk with our experienced advisors.
Whole vs Universal Life Insurance
Both whole life and universal life insurance can provide you lifelong coverage. They’re both forms of permanent life insurance. The key difference between whole life and universal life is the flexibility a universal life insurance policy provides.
A universal life insurance policy is designed to meet the changes in a person’s life. It can be aggressively funded if the policyowner has the capability and during times of tightened budgets, premium payments can be reduced or suspended altogether. The death benefit can also be increased or decreased if needed.
Universal Life Insurance Death Benefit Options
Universal life insurance gives policyowners two death benefit options: level or increasing.
With the increasing death benefit option, as the policy’s cash value grows so does the death benefit. The premiums required for this option are understandably higher.
With a universal life insurance policy, policyowners can make withdrawals without accruing interest (unlike whole life insurance). Withdrawals reduce both the cash value and the death benefit.
|Universal Life Insurance||Whole Life Insurance|
|Cash value||Yes, fluctuates with market interest rates||Yes, grows steadily with guaranteed interest rate|
|Death Benefit||Level or Increasing||Level (can increase with paid-up additions via dividends)|
Cost Differences Between Whole Life and Universal Life Insurance
Permanent life insurance policies often have many components and are very specific towards individual needs. In general, whole life insurance is more expensive than universal life insurance.
Because of the flexibility of universal life insurance premium payments, these premiums are typically lower during periods of high interest rates compared to whole life insurance premiums for the same coverage amount.
The cash value in a whole life insurance policy accumulates with a guaranteed interest rate while universal life insurance cash values fluctuate with the market. Therefore, a whole life insurance policy has fewer unknowns and will often grow more steadily than a universal life policy, which also accounts for whole life’s higher premiums.
Which Is Better: Whole Life or Universal Life Insurance?
Neither whole life nor universal life insurance is better than the other. The question is: which one is better for you?
Deciding if whole life or universal life insurance is better for you depends on your family structure, financial situation and goals, and your risk tolerance.
If you would prefer a set death benefit, level premiums, and the potential for growth, then a whole life policy may be best. However, if you would prefer to have more flexibility and options when it comes to your permanent life insurance, then universal life might be the better choice.
Not sure how much whole life insurance you need?
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Keep in mind that a permanent life insurance plan may not be the right choice for your family. Head over to our Term Life vs Whole Life Insurance page to compare the features of a term life insurance policy versus a permanent life insurance policy.