Whole Life Versus Universal Life Insurance
Death: it’s one of only two certainties in life, the other being taxes, of course. No one enjoys thinking about their own mortality, but planning for your own end is of vital importance if you want your loved ones to be taken care of as you pass from this world.
Life insurance was designed for this purpose.
However, despite being one of the most prevalent types of insurance due to death’s inevitability, life insurance is quite complicated. Many consumers get confused juggling the various types of life insurance and their differences.
Pushy life insurance sales reps often make matters worse for the consumer by forcing insurance policies down your throat that you may not want or trying to legally and ethically hide any downsides to their life insurance policy (although you can’t blame them completely as they tend to work straight commission in an industry revolving around death).
So we’re going to explain to you what exactly life insurance is and the differences between two of the most common types.
What is Life Insurance?
Life insurance is a contract between you and an insurance company. It works a lot like other types of insurance: you pay monthly insurance premiums to the company. Generally, upon your death, the company pays out a lump sum payment to the beneficiaries you named in the contract.
Life insurance contract details are based on several factors that all affect one thing: your expected lifespan.
The longer they expect you to live based on all these factors, the cheaper your premiums tend to be because you’re less likely to die. The shorter your life expectancy, the higher the premiums.
Life insurance comes in several forms, many of which are only suited for small subsections of the population. Instead of covering them all, let’s talk about two of the most common: Whole Life and Universal life insurance.
Both of these types of insurance are permanent forms of life insurance, meaning these policies last the entire rest of your life. Contrast that with term life insurance, which lasts only for a specified amount of time (we won’t cover any types of term life insurance).
Every permanent life insurance policy has a few key components:
- Premiums – Your monthly payment to maintain the policy, just like any other type of insurance.
- Death benefit – Lump sum paid to beneficiaries upon death of policyholder.
- Cash value – Part of your payment builds up the cash value. Cash value acts as a tax-deferred savings account that you can withdraw from or take loans against. Cancelling/surrendering your policy entitles you to the cash value minus any other charges.
Permanent policies do tend to have higher premiums than term policies because they are meant to last your whole life; there’s no chance that you outlive your policy term and thus you’re guaranteed the death benefit at some point, so insurers have to offset that with higher premiums.
Whole Life Insurance
Whole Life insurance is designed specifically to provide lifetime coverage to the insured. It is called “Whole Life”, after all.
Premiums
Whole Life policy premiums are fixed. They are determined when you are initially purchasing the contract from the insurance company.
Insurance premiums are determined based on how risky you are. In this case, risk is inversely correlated with life expectancy. The longer you’re likely to live, the lower the premium and vice-versa because the company can collect more premiums from your before paying out the death benefit.
Insurance companies take several factors into account when deciding your premiums.
No matter what, Whole Life premiums are generally very high due to the lifetime coverage and the cash value portion.
Death Benefit
The death benefit is paid out to the beneficiaries you named in the contract once you die. Since there’s no risk of outliving the term with Whole Life insurance, your beneficiaries are guaranteed to be paid this at some point.
Cash Value
Part of each premium goes to the cash value, which is basically a tax-deferred savings account that can be withdrawn from, borrowed against, and used to boost the death benefit.
For Whole Life, cash value grows at a fixed rate the company determines.
It’ll grow slowly at first, but when it’s large enough, you’ll earn tons of interest.
In fact, you can actually use your cash value earnings to completely your premium payments when it’s grown enough!
Surrendering your life insurance policy entitles you to its cash value at the time of surrender minus any fees.
Cash value was designed to be used while you’re alive. If there’s any cash value left when you die, the life insurance company takes it.
However, many policies allow you to purchase a rider (an additional insurance contract benefit) that guarantees the beneficiary both the death benefit AND the cash value.
An option best saved for those who want to pass down their wealth on top of supporting their family in their permanent absence.
Universal Life Insurance
Universal life is a form of permanent life insurance just like Whole Life, but the similarities mostly stop there.
Premiums
Unlike Whole Life, you can make premium payments at any time and in any amount above a defined minimum payment once you’ve made your first premium payment.
Death Benefit
Many Universal policies allow you to increase or decrease the death benefit by increasing or decreasing your premium payments.
Cash Value
Universal cash values grow based on current interest rates.
This variable amount of growth is a double-edged sword: during periods of high interest rates, your cash value will grow rapidly. When interest rates drop, so will your growth rate.
Similar to Whole Life, any remaining cash value is absorbed by the insurance company when you die unless you purchased a rider on your policy that says otherwise.
Life Insurance: How Much, And Which Type?
You’ve seen the differences. The question is, which one of these two types works best for you?
And the other question is how much life insurance do you need?
Reasons To Get Whole Life
Whole Life is an excellent choice for younger people as they have a much longer life expectancy. It’ll be pricier than term life insurance since there’s little chance you’ll die in a specified term length if you’re young, but it still will be cheaper than a 70-year old purchasing Whole Life.
If your income source is fixed, such as if you work a 9-5 job, Whole Life is an excellent choice. You’ll know exactly how much money your next paycheck will bring, making it easy to account for your life insurance premiums in your budget.
In general, Whole Life is better for those who enjoy consistency and simplicity in their budgeting.
Reasons To Get Universal Life
Universal life will also serve young people well since it’s a permanent life insurance policy. However, it’s even better for many young people due to the flexible payments. In tough economic times, you could drop your payment amount lower to free up money for other things.
Then if you have extra cash in good times, you have the option of boosting your premiums up.
In a similar vein, Universal Life may be the better choice for those with irregular income. We’re talking entrepreneurs and the self-employed. When sales/client acquisition is slow, drop the payments low. But when the customers/clients start rolling in, feel free to boost the payments back up.
Neither type of permanent insurance is meant for the elderly, as they’ll have a shorter life expectancy than younger life insurance customers.
How Much?
Estimating the amount of coverage is one of those things that’s simple but not easy, especially when most of your life is still ahead of you.
Confused?
Well, it’s simple. You’ll want to know your own life expectancy, how many beneficiaries you’ll have, what kind of lifestyle you want them to live upon death, etc.
The hard part is you can’t see the future. You can’t know with 100% certainty what every facet of your life will look like down the road and after you pass away. However, you CAN adjust beneficiaries and whatnot down the road.
When you’re young, chances are you won’t have any spouse or kids depending on you. You might not need life insurance at all, but if you want to start early, you could name family members as beneficiaries. At that point, you won’t need as much coverage because they won’t be relying on your income to survive.
However, you’ll need more coverage when you get married to cover your spouse. That amount will only increase if you and your spouse start a family.
Lastly, remember that cash value is absorbed by the insurance company upon your death unless you buy a rider that says otherwise. Spending that extra money is well worth it if you plan on passing more of your wealth on to your heirs.
