Universal life insurance vs. term: Which policy should you choose?

Universal life insurance vs. term life

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It may be difficult to decide between the two, but both have the same goal — to protect your family.

The world of insurance has its own language, full of jargon and fancy terms. It can be confusing, but at the end of the day, all life insurance products have the same purpose: To protect your family and give the policyholder peace of mind.

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Here, we’re shining the spotlight on two common types of life insurance policies: Term life and universal life.

Universal life vs. term life

Term life insuranceUniversal life insurance
Usually easy to buy
More affordable
Choose how long your coverage lasts
Lifelong protection
Fixed premiums
Flexible premiums
Builds cash value
Investment component
No-medical-exam policies available
Need a crash course on life insurance?

Before deciding between term or universal life insurance, familiarize yourself with the basics of life insurance. Learn everything you need to know in our handy guide to life insurance.

What is term life insurance?

The simplest and cheapest type of life insurance, term life offers coverage for a set period of time — usually 10, 15, 20 or 30 years. Some insurers offer 5- and 25-year terms, too. When the term expires, you typically have the option to renew your policy or convert to a permanent policy.

If you die during that term, your beneficiaries receive a guaranteed sum of money based on your premium.

What you should know about term life insurance

  • It only pays out a death benefit.

    When you die, your beneficiaries will only receive a death benefit from your life insurance provider. Universal life policies offer a death benefit as well as an added cash value benefit, which grows with the account over time.

  • It’s less expensive than permanent policies, like universal life.

    The reason isn’t subtle: There’s less risk that you’ll die during the term, and therefore less of a chance your insurer will have to cough up the money. Permanent policies, on the other hand, provide lifelong protection, so the insurer knows D-Day is coming.

  • You may be able to renew your coverage when your term ends.

    If your term expires, congrats! That means you’re still alive. At this point there are two paths you can take. You may be able to renew your policy, though you’ll probably have to undergo a new medical exam and pay a higher premium. You may also have the option to convert to a permanent policy before your term ends, if you’re younger than 70 years old.

  • Your monthly premiums may change.

    There are three types of term life insurance: level term, decreasing term and annual renewable term insurance.

    • Level term is by far the most popular policy. The premiums typically stay the same, as do the death benefits.
    • Decreasing term life insurance also has stable premiums, but the death benefits gradually decreases — either monthly or annually — over the life of the policy. It’s usually bought by those who are using life insurance for a specific purpose: To pay off their mortgage.
    • Annual renewable term insurance is the least common of the three. It offers guaranteed reinsurability for 10 to 30 years, but the price of the premiums rise as the policyholder ages. Think of it as a one-year contract. The longer a person uses this kind of term insurance, the more costly it becomes.

What is universal life insurance?

Universal life is a type of permanent life insurance, meaning it offers lifelong coverage. The policy never expires as long as you keep your payments up to date. The major difference between universal life and other permanent policies is that the payments are flexible.

Like term life, universal life offers a tax-free death benefit. However, it’s more of an investment. A portion of each premium is invested to give your policy a cash value. Once you build up sufficient savings, you can tap into your policy during your lifetime.

It can take 10 to 15 years to get to this point, but once you do, there are a few ways to leverage the cash value in your policy:

  • Borrow against your policy.

    You can take out a loan against your own policy to pay for a down payment on a house, for example. The cash value serves as collateral, and you can pay back the insurer with interest.

  • Collect it.

    You can choose to end your life insurance policy early and collect its cash value. If you go down this route, you give up your death benefit, which means your beneficiaries won’t receive the money when you pass away.

  • Pay your premium.

    In some cases, you can pay your premiums using the cash your policy has accumulated.

What you should know about universal life

  • You can adjust your premiums.

    With universal life insurance, you have the freedom to change your payments to suit your situation, like if you lose your job, after you’ve paid your first premium and you’ve built up enough cash value. This makes it appealing to those who foresee income fluctuations or can’t commit to paying the same amount of money every month.

  • The premiums increase as you age.

    Unlike term life insurance, universal life premiums can rise over time.

  • You can adjust the death benefit.

    Dubbed adjustable life insurance, universal life also gives you the flexibility to increase or decrease the death benefit. The higher the death benefit, the more expensive your premiums. To boost coverage, you’ll probably need to pass a medical exam. To decrease it to a minimum amount, surrender charges may be applied against the cash value of your policy.

  • You’ll earn a small amount of interest on the cash value of your policy.

    The interest rate is set by the insurer and is subject to change according to the market. It’s also hinged on your insurer’s investment performance, but it can’t dip below the policy’s guaranteed rate. This differs from whole life insurance, where the rates are fixed. As such, universal life is a little riskier, but it can also reap greater returns. Indexed universal life policies (IUL) are tied to an index, like the Standard & Poor 500.

  • It’s expensive.

    Permanent policies are typically more expensive than term life, as the insurer is assuming the risk of insuring you for your entire life.

  • You can find policies without a medical exam, but it will cost you.

    Most insurers want an accurate assessment of your health before offering lifelong protection. There are a handful of providers that offer no-medical-exam policies, but they typically have higher premiums to offset the potential risk of insuring you.

  • Universal life doesn’t benefit from dividend payments.

    If your insurer is a mutual company, you won’t receive any dividend payments on its profits.

Should I buy term life or universal life insurance?

Term and universal life insurance policies are designed for different purposes. Once you’ve done your research, the next step is deciding which is best for you.

Consider buying term life insurance if …

  • You’re on a budget.

    Term life is the cheapest type of life insurance. If you have financial dependents, any insurance is better than none, and a term policy is the most cost-effective option. The younger and healthier you are, the lower your premiums will be.

  • You have short-term needs.

    In other words, you only want coverage for the years that you’re paying the bills. If you die before your time, your policy will kick in to help replace your income, pay off your mortgage and debts and send your kids to college. It can offer your family a sense of financial security and make it possible for them to continue leading the same lifestyle.

  • You predict your circumstances will change.

    With term life insurance, you can reevaluate your policy as you near its expiration date. That means that if you’ve experienced major life changes, you’ll be able to adjust your next policy to reflect that.

  • You’re interested in a simple life insurance policy.

    Term life is pretty straightforward. You’re essentially renting coverage for a specific period of time. Permanent life insurance policies, like universal life, can be more complex.

Consider buying universal life insurance if …

  • You need forever coverage.

    Do you have a sizeable estate to protect? Do you want to provide your children — and perhaps even your grandchildren — with a solid inheritance? A permanent policy can help you leave a legacy. It lasts a lifetime or until you turn 121 — whichever comes first.

  • You’re looking for flexibility with payments.

    Maybe your income fluctuates or you have money stashed away in other investments. If you can’t commit to paying a fixed premium each month, this policy’s flexibility feature is very attractive.

  • You want to access the money in your policy.

    If you’re planning to buy a home, get married or apply for a loan, a universal life policy might be a good fit. Once you’ve built up substantial cash value, you’ll be able to borrow against your policy.

  • You’re treating life insurance as an investment.

    Your insurer invests a portion of your premiums to build cash value. A professional assesses market risk and makes informed decisions based on that. If you’re interested in turning your life insurance policy into a financial asset and are comfortable with risk but don’t have the discipline or expertise to invest on your own, it’s worth looking into universal life. Premiums are higher than those for term life, but so are the potential returns.

  • You’re young and healthy, and your family has a history of serious health conditions.

    Does cancer, heart disease or strokes run in your family? If your family medical history isn’t on your side, it’s a good idea to lock in a good rate as soon as possible, while you have no health complications.

Can I buy both term life and universal life insurance?

Yes. You can ladder your insurance, which means holding two or more life insurance policies at the same time. When you apply for additional coverage, be prepared to explain why you want more insurance and be ready to show proof that you can pay for both.

The purpose of life insurance is to give your family a sense of financial security. As you go through life, your circumstances and needs may change, and your life insurance should reflect that.

These are some of the reasons why you might want to purchase both term and universal life insurance:

  • You can’t afford the coverage you want.

    Many families start with term life insurance because it’s the cheapest option, and then buy a permanent policy later when they’re earning more money.

  • You need more coverage.

    Maybe you’ve bought a home or upgraded to a bigger home. Maybe you’ve gotten married or had a child. Maybe you’ve started a business. You may consider adding coverage to cover those new financial obligations.

  • You’re applying for a loan.

    Life insurance can serve as collateral and assure the lender that you have every intention of paying the money back.

Bottom line

When you’re tossing up between term and universal life insurance, think of your financial obligations and goals. If you have short-term needs or a tight budget, a term life policy can offer protection and security for a specified period of time. If you’re interested in treating life insurance as more of an investment, you might want to look into a cash-value policy like universal life.

Once you’ve settled on a policy, compare providers to make sure you’re getting the most value for your money.

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