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What's the Difference Between Whole Life Insurance & Universal Life Insurance?

Life Insurance
Woman and daughter in a tent: difference between whole life insurance and universal life insurance

As you evaluate insurance options, it's critical to understand the difference between whole life insurance and universal life insurance in order to really know which type of policy might work for you. And while insurance terminology can be confusing, a few highlights can help you make sense of the features available.

Several basic offerings are common to both types of policies. Whole life and universal life can each provide permanent coverage, which will last as long as you continue to pay the required premiums. What's more, you can potentially build up cash value in either policy and use that money later in tax-advantaged ways, such as to help pay premiums or by taking out a loan against your policy. (Keep in mind loans taken out against a policy accrue interest, may generate an income tax liability, could reduce the policy's account value and death benefit, and may cause the policy to lapse.)

Understanding Whole Life Insurance

Whole life insurance is a form of permanent life insurance with guarantees that help make for a relatively predictable policy.

For one thing, your premiums typically don't change with whole life insurance, allowing you to plan for decades of the same payment amount. Because of that guarantee, however, you may pay higher premiums in the early years than you would with a universal life policy.

Insurance providers can offer what's called an illustration of a policy. This shows projections on how the policy should perform given a specified set of parameters applied to its features. With a whole life insurance illustration at the time of issue, you more or less know what your guaranteed cash value will be in any given year, based on those parameters, which makes for further predictability. That may be helpful if you plan to use that cash value in the future.

Some whole life insurance policies, known as participating policies, pay dividends based on cash value. You can use those funds to increase your death benefit, reduce the amount you need to pay out-of-pocket for premiums, or for other purposes. That said, dividends are not guaranteed, so you may not receive payments in a given year (or possibly ever).

Understanding Universal Life Insurance

Universal life insurance typically provides a little more flexibility than whole life, particularly when it comes to paying premiums.

You can pay any amount you want (subject to the terms of the policy), varying coverage accordingly and as long as you continue to pay the costs of insurance for your policy. If your cash value is sufficient to pay those costs, you might even be able to cover your premium payments in some years.

The cash value you accumulate depends in part on how your life insurance company credits your account. The cash value may grow faster or slower than you assume, so it can be hard to predict how much cash value might be available to you in the future. If things don't go as well as you'd planned, you may end up paying more in premiums to keep your policy funded.

The amount your policy earns may depend on interest rates, financial markets or other factors. Depending on your tolerance for risk, you may be able to pursue the potential for higher returns in your policy. That risk, however, comes from the essentially unknown nature of those return rates — they may be nonexistent, or even negative.

Choosing Between the Two

When it comes to insurance policies, one isn't necessarily better than the other — the key is to develop a strategy that best suits your needs. Between whole and universal life insurance, your choice may come down to whether you prefer guarantees or flexibility.

For example, you might consider the guarantees of whole life if you have a specific need in mind, and you plan to use your cash value for that need. Or perhaps you're certain you want the death benefit to remain in place.

That said, universal life insurance has other useful features and is typically easier to afford in the policy's early years (which can help when you're young). As a result, it can be easier to manage your personal cash flow with universal, and you might be able to pay nothing out-of-pocket at times if your dividends do well enough. Again, though, if the cash value in your account isn't sufficient to pay the costs of insurance, you may need to make more significant premium payments to prevent your policy from lapsing. As you grow older, those insurance costs tend to rise.

Ultimately, the choice depends on your individual needs. Now that you know the difference between whole life insurance and universal life insurance, you can begin determining what's most important to you. You might also consider discussing your goals with a financial representative to help find a policy that offers the protection you need.

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