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Universal vs. variable life insurance

How these policies earn money is the biggest difference

Updated

Fact checked

Universal and variable life insurance are both permanent policies that build cash value. But they differ in two major ways: how they treat that cash value, and how they treat premiums.

Universal vs. variable life insurance

These are the key features of these types of permanent policies:

Universal life insurance
Variable life insurance
Lifelong coverage
Yes
Yes
Guaranteed death benefit
Yes
Yes
Builds cash value
Yes
Yes
Guaranteed cash value returns
Yes
Yes
How cash value grows
According to a fixed interest rate set by the insurer.
Based on the performance of your investments.
Premium payments
Flexible — the policyholder can adjust the amount and frequency of payments. And once you’ve built up enough cash value, you can use it to pay your premiums.
Flexible — the policyholder can adjust the amount and frequency of payments.
Potential to earn dividends
Yes — if you’re with a mutual life insurance company.
Yes — if you’re with a mutual life insurance company.

How does each policy earn money?

Both universal life and variable universal life have an investment component. However, here’s how your cash value is invested differently between universal and variable life insurance:

  • Universal life insurance. Your cash value earns interest at a rate set by the insurer. That figure can rise and fall to reflect current interest rates, but by law, it can’t drop below 2%. Your insurer will also set a minimum interest rate, which might be higher. In this way, the returns on universal life insurance policies are more predictable.
  • Variable life insurance. At purchase, your insurer will present a portfolio of subaccounts, like stocks, bonds and mutual funds. You can choose how you want to invest your cash value. Your insurer manages these accounts, and your cash value grows in line with the performance of those investments. Unlike universal life, the amount of money you can earn with variable life insurance isn’t capped.

Which policy is right for me?

If you want to use life insurance for investment purposes, both policies work. But the best policy for you comes down to your risk tolerance, and how much control you want over the way your cash value is invested.

  • Universal life insurance. If you’re more risk-averse but want to take advantage of flexible premiums, universal life could be a good fit. Just keep in mind that tweaking your premium might also change your coverage and death benefit amount.As for the investment component, the insurer will cap your cash value returns, so be sure to ask about the “participation rate” before signing up. If the limit seems low, shop around to learn the rates set by other insurers.
  • Variable life insurance. The cash value of variable life policies is invested more aggressively, and it’s subject to market conditions. This means there’s a greater potential for returns and losses. There’s also no guarantee on return, so if your investments perform poorly, you might be left with a lower cash value or higher premiums.If you’re comfortable with risk and have a background in investing, you might be willing to take the gamble. You’ll also have more of a say over the investments.Thanks to the level of risk and uncertainty, variable life policies are offered by prospectus only.

Will I pay tax on either policy?

Like all permanent policies, the cash value grows tax-deferred and isn’t considered to be taxable income. For this reason, universal and variable life policies are ideal for those who want to build a tax-free inheritance for their beneficiaries.

You can benefit from the tax break during your lifetime, too. Once you’ve accumulated enough cash value, you can start taking out tax-free loans against your policy, using the cash value account as collateral.

How does variable universal life insurance work?

This hybrid policy combines features from variable and universal life insurance. It’s a permanent policy that offers flexible premiums and the ability to invest your cash value in the investments of your choice.

If your investments are performing well, there’s potential for exponential returns. But if the market dips, that loss could diminish your cash value, and your insurer might charge a higher premium to compensate.

Compare permanent life insurance

Name Product Issue age Minimum Coverage Maximum Coverage Term Lengths Medical Exam Required
Prudential
18 - 75 years old
$100,000
$10,000,000
10, 15, 20, 30 years
Yes
Customize your term life insurance with a long list of life and disability riders. Get a free quote on Policygenius.
Transamerica
18 - 75 years old
$25,000
$10,000,000
10, 15, 20, 25, 30 years
Depends on policy
Purchase a policy worth anywhere from $25,000 to $10 million, with the option to skip the medical exam. Get a free quote on Policygenius.
MassMutual
18 - 80 years old
$2,000
$10,000,000
10, 15, 20, 25, 30 years
Depends on policy
Purchase term life insurance up to age 80 with Finder's #1 ranked company. Get a free quote from this A+ rated insurer on Policygenius.
AIG
AIG
20 - 85 years old
$5,000
$2,000,000
10, 15, 20, 25, 30, 35 years
Yes
Buy term life insurance all the way up to age 85, and choose a policy that lasts up to an incredible 35 years. Get a free quote on Policygenius.
John Hancock
18 - 65 years old
$25,000
$1,000,000
10, 15, 20 years
Depends on policy
Score a low rate on term life insurance with discounts and rewards for your healthy habits. Get a free quote on Policygenius.
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Compare up to 4 providers

Bottom line

Both policies offer flexible premiums and become a cash asset over time. But they differ in their approaches to investment: universal life insurance grows at a fixed rate, while variable life insurance is subject to the ups and downs of the market.

As part of your research, be sure to compare life insurance providers.

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