Whole life vs. universal life insurance

These permanent policies build cash value, but they suit different types of investors.

The concept behind life insurance is simple: Pay now to protect your loved ones when you’re gone. But if you’re interested in buying lifelong protection, the ins and outs of insurance get more complex.

Whole life and universal life are similar products in that they’re both permanent policies and investments that build cash value over time. While they’re financial assets, they have key differences in terms of flexibility and how your money is invested.

Whole life vs. universal life

What you should know about whole life insurance

• You may be able to purchase a no-exam policy.

  This is known as simplified issue life insurance. Since your insurer is taking on more risk, it charges a higher premium, and the death benefit is usually capped at $500,000.

• Your premiums will typically stay the same.

  You can expect to pay the same amount every month. That being said, there are a handful of whole life policies with increasing premiums, so be sure to read the fine print. For premiums that stay the same, you’ll want to sign up for a guaranteed level premium policy.

• You’ll probably be paid dividends.

  If your insurance company is a mutual firm, you’ll get annual dividends that reflect its profits and success. You can choose to receive them in cash or let them accumulate interest. You can then use the dividends to reduce your policy’s premiums or buy more coverage. Even if the company is financially strong, dividends aren’t always guaranteed, so think of them as a bonus.

• It forces you to save.

  Whole life bundles your insurance and investment, so it works as a forced savings vehicle. This is an attractive feature for those who don’t have the discipline to save on their own. It’s also popular among people with financial assets to protect, as the cash value can be used to pay estate taxes.

• The cash value increases regardless of market conditions.

  With each premium payment, your cash value increases. Whole life offers fixed returns, while universal life’s returns fluctuate with the market. This makes whole life a more secure permanent policy for the risk-averse.

What you should know about universal life

• You can change your premiums.

  You have the liberty to adjust the amount and timing of your payments to suit your financial situation. This feature is unique to universal life insurance and is ideal for those whose income fluctuates or who can’t commit to steady monthly payments. Keep in mind that this flexibility kicks in after you’ve paid your first premium and built up enough cash value.

• The premiums increase as you age.

  Unlike whole life, universal life premiums can rise over time.

• You can increase or decrease the death benefit.

  The flexibility of universal life policies extends to the death benefit as well, which you can adjust at will. The higher the death benefit, the more expensive your premiums will be. To increase coverage, you’ll most likely need to pass a medical exam. To lower it to a minimum amount, your insurer may apply surrender charges to the cash value of your policy.

• The interest rate is subject to change.

  With universal life, you’ll earn interest on the cash value of your policy, but the rate isn’t fixed. It changes based on market conditions, without dipping below your policy’s guaranteed rate. This makes universal life a riskier investment, with potentially greater returns. Indexed universal life policies (IUL) are tied to an index, like the Standard & Poor 500 or Nasdaq 100.

• You can get a no-medical-exam policy, but it will cost you.

  Like with whole life, it’s possible to find universal life insurance policies out there that don’t require a medical exam. However, you’ll pay more for this convenience since the insurer is assuming the risk of covering you for life without getting an accurate assessment of your health.

• 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 whole life or universal life insurance?

Ultimately, your life insurance needs should suit your financial situation and goals. While whole life and universal life are similar in many ways, they have key differences that may sway you one way or another.

These factors may help you make an informed decision.

Consider buying whole life insurance if …

• You like stability.

  With whole life, everything is fixed: Your premiums, the death benefit and the interest you’ll earn on your cash value benefit. All you have to do is continue making your payments and trust that everything else is being taken care of.

• You’re working with a budget.

  For planners and careful savers, whole life is an ideal permanent life insurance policy. The premiums are consistent, so you know exactly how much you owe every month, which makes budgeting easier.

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

  If you have a family medical history of cancer, strokes or heart disease, you might want to lock in a good rate now, while you have no health complications. Whole life is typically the least expensive type of permanent life insurance.

• You want to invest without thinking about it.

  Your insurer manages the investment portion of your policy, so you don’t have to figure out how to grow the funds yourself. With universal life, you have to participate a little more by choosing which investments you’d like to be involved in.

Consider buying universal life insurance if …

• You want to change your coverage to suit your circumstances.

  In the world of life insurance, universal life policies offer an unparalleled degree of flexibility. You can adjust the amount and timing of your payments, as well as the death benefit.

• You’re comfortable with risk.

  Unlike whole life, universal life’s returns aren’t fixed. They’re privy to market conditions, meaning they come with greater risk, but offer potentially greater returns. If you’re interested in risky investments but don’t have the discipline or expertise to invest on your own, it’s worth exploring universal life insurance.

• You like the idea of your premiums being tied to interest rates.

  Typically, universal life premiums are lower when interest rates are high, and vice versa. This isn’t the case with whole life, whose premiums stay the same. Also, the interest rates for universal life policies are adjusted monthly. This means that during periods of high-interest rates, policyholders may see their cash values rise rapidly.

Can I buy both whole life and universal life insurance?

Yes, but it’s unusual to buy both whole life and universal life insurance. You can purchase multiple policies, either with the same or different providers, but you must be able to justify the additional coverage. When you apply, you can expect to be asked why you want more insurance and to prove that you can pay for both.

Your life insurance should reflect your financial obligations, and that’s where laddering policies come in. Typically, people supplement their permanent insurance with term life to cover a specific need or time of their life.

Bottom line

Whole life and universal life both offer lifelong coverage. They also turn into cash assets over time, but universal life is a riskier investment that requires more participation on the policyholder’s part. For stable premiums and interest rates, whole life might be the better choice. If you’re a keen investor who wants the freedom to tweak your policy, look into universal life.

Either way, be sure to compare providers and policies before signing the dotted line.

Frequently asked questions

• What is indexed universal life insurance?

  Indexed policies are tied to an index, such as the Standard & Poor 500 or the Nasdaq 100. As the policyholder, you can allocate a percentage of the cash value of your policy to a fixed account as well as an indexed account. The cash value gains are then tied to the success of the market.

• What are the differences between the rate of return?

  Whole life has a guaranteed rate of return, excluding dividends, while universal life policies have a minimum (floor) and maximum (cap), which are set by the insurance company.

• Are the costs of insurance fixed?

  Whole life insurance has fixed premiums. Universal life offers flexible premiums, but the prices typically rise as the policyholder ages.

• Can I use the cash value of my policy to pay my premiums?

  Yes. Once your policy has accumulated enough cash value, you can tap into it to pay your premiums. This is called being paid up, and it can potentially save you money in the long term. Chat with your life insurance provider to find out if you’ve built up the cash value to activate the benefit.