A life insurance policy is either term-based or permanent. Term life insurance offers protection for a limited period. If you die within that period, your beneficiaries receive the death benefit. A permanent life insurance policy, however, has no expiry date. Your policy pays out regardless of when you die. Generally, permanent policies also include an investment component — cash value. Your policy’s cash value grows on a tax-deferred basis, and you can tap into it whenever you want.
If you are looking for a permanent life insurance policy, you have two options: whole life and universal life insurance.
Both of them offer lifelong coverage and the potential to build cash value over time. But that is where the similarities end. Whole life insurance offers a lot of guarantees (a consistent premium rate and death benefit and predictable cash value growth) while the main attraction of universal life insurance is its flexibility.
So, which one is better — whole life or universal life insurance? Continue reading to find out the answer.
Whole Life Insurance
Whole life insurance is a type of permanent life insurance. The coverage does not come with an expiry date; instead, it lasts for as long as you pay the premiums. Lifelong coverage, however, is not the only difference between term and whole life insurance. Whole life policies also include a savings component, called cash value, which grows over time on a tax-deferred basis. Which means no taxes are paid until you withdraw the cash value. As a result, your money grows at a faster rate than it would in a bank saving account.
The life insurer divides your whole life premiums into three portions:
- One part covers the cost of insurance
- One part takes care of the administrative fees
- One part funds the cash-value account
The insurer invests the money in the cash-value account into a conservative-yield form of investment. Since whole life policies promise a guaranteed minimum return, you are protected against severer market fluctuations. But when the insurer’s investments perform well, you earn a better return.
Generally, the cash value grows at a slow pace in the first few years and then picks up the pace later. As you grow older, the cash value growth rate slows down again as a greater chunk of your premium payments is used to cover the cost of insurance.
Your policy’s face amount (that is, the death benefit) is for your loved ones while the cash value is available to you while you are still alive. If you do not use all of it, the insurer claims the remaining cash value. When you die, your loved ones receive only the death benefit, not the unused cash value.
So, how can you tap into your policy’s cash value? You can access it in many ways, such as:
- to increase the death benefit
- to take out a loan
- to make a withdrawal
- to pay life insurance premiums
However, lifelong coverage and a built-in investment account — the two main features of whole life insurance — come at a price. If you want a whole life policy, expect to pay six to 10 times more than a comparable term life plan. All the same, whole life insurance can be a good option for some people, despite the high cost.
Who should consider Whole Life Insurance?
You may want to consider it if you:
- Have a lifelong dependent – Parents of a child with special needs or someone else with a lifelong dependent may find whole life insurance a better option. That is because it pays out the death benefit to your beneficiaries regardless of when you die, as long as the policy is active.
- Want an additional investment vehicle – Affluent people who have already maxed out traditional investment vehicles may find the cash-value component to their liking. It gives a better return than a bank savings account, though the interest rate is not as high as most traditional investment options.
- Wish to leave an inheritance – If you want to leave money for your loved ones or a charity, a whole life plan could make sense for you.
- Want to preserve the value of your estate – Certain costs, like probate fees and taxes, can chip away at the inheritance you want to leave your family. Putting a whole life insurance plan in place can ensure your loved ones inherit all the money you intended them to receive after your death.
Pros and cons of Whole Life Insurance
Just like any other financial product, whole life insurance comes with its own set of advantages and disadvantages.
Universal Life Insurance
Universal life insurance is also a type of permanent life insurance. This means you get lifelong protection, provided you pay the premiums. Most universal life insurance policies also build cash value, but they generally offer more flexibility than whole life insurance.
For example, you can adjust premium payments, within limits. Some universal life policies also let you select the investment options for your cash value. You can withdraw from or borrow against your policy’s cash value any time you want. Additionally, you can also use the cash value to purchase more protection or pay future premiums.
Universal life insurance mainly comes in three types:
Guaranteed Universal Life (GUL) Insurance
Guaranteed universal life insurance policies mean a guaranteed level premium and death benefit. Which means they both will remain the same throughout. You pick an age when the coverage ends, such as age 90, 100, 110, etc. The higher this number, the greater the cost of insurance will be.
These policies do not build much cash value, if they build any at all. The upside is that guaranteed universal life insurance is cheaper than other types of universal life plans. However, remember, if you miss one payment, your policy could lapse. Since there is no or little cash value, the insurer cannot use it to cover a premium payment.
Indexed Universal Life (IUL) Insurance
These universal life insurance policies provide lifelong protection and offer the freedom to increase or decrease premium payments and the death benefit, within certain limits. The built-in investment component is usually linked to a stock market index.
An IUL policy comes with a minimum and maximum guaranteed rate of interest. So, even if the stock market tanks, you are not likely to lose all of your cash value. On the downside, you will have limited gains when the financial market is in a strong uptrend.
IUL policies are more complex and expensive than guaranteed universal life insurance.
Variable Universal Life (VUL) Insurance
A VUL policy also lets you adjust your premiums if your needs or financial situation changes. However, these policies require a closer monitoring than other types of universal life plans. That is because you pick the sub-accounts that impact your cash value growth. If you invest wisely, you can get good returns. Conversely, if your investment choices do not play out as expected, the cash value might get completely wiped out.
Who should consider Universal Life Insurance?
Universal life insurance policies could make sense if:
- You want coverage that lasts as long as you live – A guaranteed universal life plan could work well for someone who primarily wants lifelong protection and is not so much interested in building cash value.
- You want more flexibility - Life insurance can change over time, as can your financial situation. Indexed and variable universal policies give you the freedom to tweak the premium payments, within pre-defined limits.
- You want more investment options – With universal life insurance, you can pick investment options that suit your level of risk tolerance and long-term financial goals. For example, variable universal plans let you invest the cash value in sub-accounts of your choice.
Pros and cons of Universal Life Insurance
Let’s look at the advantages and disadvantages of universal life insurance.
Differences between Whole Life and Universal Life
Whole life insurance offers a variety of guarantees but little control over how your cash value is invested. With whole life insurance, you get three kinds of guarantees:
- Your premium rate will not increase
- The death benefit will not become less
- A minimum return rate on your cash value
However, you do not have any say in how the cash value is invested. The insurer decides that.
Universal life policies can offer more choices and flexibility. For instance, indexed universal and variable universal plans let you adjust the size of the death benefit if your insurance needs change in the future. You can also adjust your premium payments if you want. Plus, variable universal policies allow policyholders to select investment options that work best for them. On the other hand, those who care more for lifelong coverage than the investment component of the cash value account may find guaranteed universal a better option.
Which Policy Would be Better for You?
Finding the right whole or universal life insurance policy comes down to your family’s needs and financial needs. If you are someone who does not like any guesswork after purchasing life insurance, whole life insurance may be right up your alley. Your premiums will not increase, the death benefit remains the same throughout, and the cash value earns a guaranteed minimum interest rate.
But if flexibility is important, universal life insurance may be a better choice. You can adjust the death benefit and premium payments up and down, within defined limits, if needed. Universal life insurance policies may give better returns on cash value than whole life, but it is not guaranteed.
Both whole life and universal life insurance offer unique benefits. But the choice between the two entirely depends on your life insurance policy needs and long-term goals. If you want permanent life insurance but are not sure which one is better for your situation, speak to a life insurance expert at Dundas Life. And if you have already made the decision, we can help you get the right coverage at the lowest price.