Whole vs. Universal Life Insurance

Definitions & Differences Between Whole and Universal Life Insurance

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Whole life and universal life are two popular forms of permanent life insurance. Both include a cash value, and are designed to last for your entire life. However, there are several important differences.

Learn the similarities and differences between whole and universal life insurance, as well as when it might make the most sense to choose one type of insurance over the other.

Key Takeaways

  • Both whole and universal life insurance can provide lifelong insurance coverage.
  • Whole life insurance is more predictable, but less flexible. It often has consistent monthly payments, and cash values are outlined when the policy is issued.
  • Universal life insurance premiums can be flexible, but the cash value is not predetermined when the policy is issued.
  • Whole life insurance may appeal to you if you’re seeking certainty. Universal life insurance may work well if you prefer flexibility and have a somewhat higher tolerance for risk.
  • If you don’t need permanent coverage, term life insurance may be an excellent alternative.

What Are Universal Life Insurance and Whole Life Insurance?

Whole life and universal life insurance are forms of permanent life insurance coverage. They’re designed to cover you for your entire life. These two types of policies share several essential features.

Cash Value

Both whole life and universal life are permanent life insurance that include a cash value. This can help smooth out the premium payments required to keep a policy in force. In the early years, you typically pay more into the policy than it costs to provide life insurance. These “extra” payments allow the cash value to grow over time, which ideally, will help fund coverage for the rest of your life.

The cash value in a life insurance policy grows tax-deferred. That means you won’t pay taxes on that money until you access it via withdrawals or loans, if your policy allows that. Any unpaid loans reduce the death benefit, and both withdrawals and loans can potentially cause you to lose coverage.

Lifelong Coverage

As long as sufficient premiums are paid, your coverage can last for your entire life. But if the policy runs out of money, your coverage can lapse (or end). That can happen if you don’t make the required premium payments. Note that your cash value may gradually decline due to deductions (for the cost of insurance and other charges) or withdrawals. In that case, additional premium payments may be required to maintain coverage.

If you use your cash value for policy loans or withdrawals, you risk losing coverage, and you may have to pay taxes on any gains from your policy (more on gains in the table below).

Surrender Periods

Both universal and whole life insurance policies frequently have a surrender period that may last up to 20 years after the policy is issued. During this time, any withdrawals from the cash value, including full policy surrenders, will come with a charge. The amount you’d receive from the policy upon surrender is called the cash surrender value, which is the cash value minus any applicable surrender charges. 

Surrender charges can be steep, especially in the early years, but usually decrease on an annual basis until the surrender period expires. Make sure you know how long the surrender period is for any policy you consider purchasing and how surrender charges are calculated.

Universal Life Insurance vs. Whole Life Insurance

While whole life and universal life policies share some key features, they work differently, especially regarding premium payments and how the cash value is determined.

Policy Features Whole Life Universal Life
Cash value crediting rate Guaranteed, cash values are typically fixed at policy issue Minimum guaranteed interest rate; actual rate depends on current interest rates
Dividends Yes, for participating policies No dividends
Premiums Typically level premiums Flexible premiums
Stock market exposure None Potential market exposure

Cash Value Crediting Rate

Whole life insurance typically uses a fixed crediting rate to grow your cash value, so you know exactly what the cash value will be in any given year. As a result, whole life insurance is more predictable. 

Universal policies credit your cash value at a rate that is not known in advance—it’s dependent on current market interest rates or, for some policies, stock market gains and losses. As a result, there’s no way to predict how much cash value a universal policy will have at any given point in time. If the cash value doesn’t grow sufficiently, you may need to pay more than you expected into the policy to prevent lapsing.

Dividends

Some whole life policies, known as participating whole life, can pay dividends. Dividends are not guaranteed, but if the insurance company has better-than-expected performance, policyowners may receive dividends. You can use dividends in several ways, including buying more life insurance, reducing required premiums, and earning more interest. Universal life policies do not pay dividends.

Premiums

Traditional whole life policies require premium payments that are typically consistent throughout the life of your policy. You may be able to pay these premiums monthly, annually, or even quarterly. While some variations exist, the idea is that your coverage is guaranteed if you pay the required premiums. With universal life, you can choose how much you pay in premiums, although you need to pay enough to maintain a cash value sufficient to pay policy expenses.

Historically, whole life insurance was the most popular form of coverage (as measured by annual premiums). Today, universal life insurance has a market share that’s roughly equal to whole life’s share. That may be due, in part, to the flexibility available with universal policies.

Stock Market Exposure

Whole life insurance does not participate in financial markets. And while not all universal policies are linked to the markets, with variable universal life or indexed universal life insurance, you may have exposure to stock market gains and losses. Especially with variable universal life policies, it’s possible to lose money in the markets. This can jeopardize your coverage if things go badly.

Which Is Right For You?

The right type of life insurance coverage primarily depends on how much certainty you want, if you need flexibility, and your appetite for risk.

Universal Life

Universal life insurance might make sense for someone who needs permanent life insurance and is comfortable with some uncertainty.

The cash value in a non-variable universal life policy may have a guaranteed minimum interest rate, but since the cash value is credited based on current rates, you can’t predict how much you’ll earn inside the policy. As a result, you need to be willing and able to make additional premium payments into the policy to keep coverage in force if the cash value starts to dwindle. When money is tight, that’s not a good situation. But if you have more income than you need, it might be easy to increase premiums in a universal policy.

On the flip side, if you’ve built up a cash value, you can pause or delay premium payments when money is tight. This is because the policy will deduct the cost of insurance and other charges from the cash value. In a typical whole life policy, you don’t have this option.

Universal life may be right if you want to pursue some growth inside of your life insurance policy, based on fluctuating interest rates, stock market benchmarks (like the S&P 500), or direct market investments. This all depends on the specific type of universal life policy.

Those with an appetite for risk may choose a variable life insurance policy, which can gain and lose money according to the performance of mutual-like subaccounts the policyholder chooses. But if the accounts perform poorly, extra premium payments may be required to keep the policy from lapsing.

With any universal life insurance policy, if you’re fortunate, the cash value may grow at an attractive rate. When that happens, you can pay lower premiums, access a growing cash value through loans or withdrawals, or provide a bigger death benefit to beneficiaries.

Whole Life

Whole life insurance might be right if you need permanent insurance and prefer a high level of certainty. 

Your premiums, death benefit, and cash value are often set when you buy a whole life policy. As long as you keep paying the required premiums, you know what benefits are available to you and your beneficiaries. If you don’t like the idea of taking your chances—whether that’s hoping for high crediting rates or relying on investment returns—you might be most comfortable with a whole life insurance policy.

That could be the case if you need a no-surprises life insurance benefit to provide for children with special needs or if you have a business partner and need to fund a buyout after one partner dies. 

Just keep in mind that with predictability comes a lack of flexibility. In many cases, if you fail to make premium payments, the policy will lapse—even with a substantial cash value. Whereas universal life policies are designed to draw premium payments from the cash value, whole life policies are not. However, there’s a way around that: You may be able to purchase an automatic loan provision (APL) rider for your whole life policy that will kick in if you miss payments by pulling the necessary funds from your cash value.

Alternatives to Universal and Whole Life Insurance

If you don’t need permanent insurance, term life insurance might be an excellent alternative to permanent policies. With term insurance, you purchase coverage for a set number of years (15 or 30 years, for example). You’re covered for as long as you continue to pay premiums or until the term ends, and you can stop paying premiums if you no longer need protection.

Term life insurance premiums are often lower than permanent life insurance premiums because you do not need to build up a cash value (term policies have no cash value). But term life insurance is not designed to cover you for your entire life—it’s best for time-limited needs like protecting a young family from the early death of a parent.

If you have short-term needs and long-term needs, consider a mixture of term and permanent coverage. You can use term life insurance for temporary protection (such as ensuring that the mortgage gets paid off), and a smaller permanent policy can provide long-term coverage.