Universal Life versus Whole Life

Universal life insurance is also called adjustable life insurance because of the flexibility it offers. You have the ability to reduce or increase your death benefit and adjust your premiums (subject to certain limits) once there is money in the account.

How Universal Life Insurance Works - When you make a payment to your universal life insurance plan, part of it goes into an investment account, and any interest accrued is credited to your account. The interest you earn grows on a tax-deferred basis, increasing your cash value.

You can adjust the death benefit when needed, increasing it (often subject to a medical exam) if your circumstances change, or lowering it to reduce premiums. Alternatively, you can use your cash value to pay premiums as long as there is enough money in that account.6

Pros and Cons of Universal Life Insurance - The ability to adjust the face value of your coverage without surrendering your policy is an attractive feature of universal life coverage. As your financial circumstances or responsibilities change, you can increase, decrease—or even stop—premium payments.

Another perk is the ability to partially withdraw or borrow funds from the cash value. However, you have to keep track of withdrawals, because they reduce the cash value amount—if you withdraw too much, you may have little left in a time of need. If your premiums don’t cover the cost of insurance and you have no cash value, then your policy could lapse.

Another downside of universal life insurance is the interest rate, which is often dependent on market conditions. If the policy performs well, there are chances of potential growth in your savings fund. On the other hand, if it performs poorly, then the estimated returns aren’t earned—and that might increase your premiums.

Another Negative Feature: the fees. As with all permanent life insurance policies, surrender charges may be levied at the time of terminating your policy or withdrawing money from the account, especially in the early years

Key Differences - The biggest difference for policyholders between whole and universal life is the guarantees:

Whole life has a guaranteed death benefit, level premiums, and growing cash value. This growth in cash value comes from annual dividends that are credited to policies.

Universal life provides flexibility in lieu of guarantees. You can pay more or less each year for your policy (within limits), and this also will allow the cash value and death benefit to fluctuate. Rather than dividend payments, UL policies are credited based on interest rates. This can lead to a UL policy becoming underfunded, causing premiums to rise. If you can’t meet those payments, then the policy can terminate.

With whole life, you pay higher premiums for the guarantees you are given. An equivalent universal life policy will cost less but will also carry a certain degree of risk to policyholders.