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So, you’ve decided that term (temporary) insurance is not the right product for you and that you want to buy permanent life insurance and take advantage of the living benefits. The two most common products to consider will be Universal Life Insurance and Whole Life insurance. What’s the difference?
In the most simple term:
Whole Life insurance provides level premiums and that wonderful option of pulling some money out when you need it the most.
Universal Life Insurance provides pretty much the same benefits as whole life insurance but is more flexible. Universal life can change when life events need you to do so.
Whole Life Insurance
Also referred to as traditional life or permanent life insurance, whole life insurance is the oldest form of life insurance available. This type of life insurance offers several guarantees that other forms of life insurance do not offer, and has some living benefits that are not available with term insurance. Probably one of the most popular components of whole life insurance is the cash value account.
The cash value account is a result of the policyholder paying more than the actual cost of the death benefit with every periodic premium. A portion of the premium payment is dedicated to paying for the life insurance while the remaining portion is diverted to the cash value account thus creating equity for the policyholder.
How Does the Cash Value Grow?
When you purchase your whole life insurance policy, the insurance carrier will state in the contract that they will pay a minimum amount of interest on the money that is being placed in the cash account. Basically, the insurance company is investing your money for you and then returning a portion of the earnings back into your cash account.
As your cash value continues to grow while you are making premium payments and earning interest, over time your cash value can become substantial. As the policyholder, there are several options for getting access to your cash value:
- Use the funds to pay your premiums
- Withdraw funds up to your basis – your death benefit will be reduced by the withdrawal amount
- Withdraw your gains on a taxable basis – your death benefit will be reduced by your withdrawal amount
- Take out a policy loan – no credit check but interest will be charged. Unpaid loans and interest will be deducted from the death benefit.
- Exchange and convert cash account for an income annuity.
- You can exchange your policy value for long-term care insurance.
None of these living benefits are available with term insurance. It may be cheaper but it’s usually just a death benefit and of little help while you’re living.
Universal Life Insurance
Universal Life Insurance (UL) is considered a hybrid life insurance policy because it combines elements of term insurance and a savings and investment option. A UL policy allows the policyholder to build a savings account and provides a death benefit at the same time. The policy also allows the flexibility that no other type of insurance will allow:
Flexible Death Benefit – With term and whole life insurance, the death benefit is typically etched in stone. However, with a UL policy, the policyholder has the ability to increase or decrease the death benefit (within the contract limits) which eliminates the need to purchase a separate policy. Please note that an increase in the death benefit could trigger additional underwriting or medical exam.
Flexible Payments – As your financial needs change during your life, you will likely discover that the premium flexibility in your UL policy is a great option. This flexibility allows you to increase or decrease your premiums as needed, or even skip some payments if there is sufficient cash value built up in your cash account.
Increase the Death Benefit – If you reach a point where you have substantial cash value that you do not intend to take out, you can usually trade all or some of it for an additional death benefit.
Paid-Up Policy – Once you’ve reached a considerable amount of cash value in your account, you can just stop paying premiums and instead, have them deducted from your cash account. Always check with your agent or company before you do this to make certain you have the equity to carry your policy over your lifetime.
Policy Loans – You can easily access your cash value via a policy loan. You will be charged a small amount of interest but you are not required to repay the loan. Unpaid loans and interest are deducted from the death benefit.
Policy Withdrawals – Rather than a loan, you have the option to make a withdrawal of your cash value. You do not repay it and you are not charged interest. Depending on the withdrawal amount, your death benefit will be reduced by the amount of the withdrawal
Full Surrender – If you want all of the cash in your policy and do not need the death benefit, you can surrender the policy and receive all of the accumulated cash minus any surrender charges.
After we review Universal Life and Whole Life Insurance, the main difference that really stands out is the flexibility in the universal life policy. And, although we didn’t discuss it, Universal Life can be much cheaper than whole life because you can control how much you want to fund the policy.
But be careful, underfunding your coverage may result in a lapse and leave you without this needed coverage. The good news is, however, your insurance company will provide you with an annual statement which will include a guaranteed coverage period, therefore, providing you with a fair warning if your policy is running out of money.
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