Term Insurance vs. Universal Life Insurance

Understanding the different types of life insurance products are and how they differ from one another can be confusing for those not associated with the insurance or financial services industries.  In this article, the similarities and key differences will be highlighted about the most common types of life insurance, term, and universal life insurance.  It is crucial to have a substantial understanding of exactly how these products function so that you are able to make an informed decision and choose the life insurance that best suits your needs and budget. So, let’s discuss Term Insurance vs. Universal Life.

The Similarities       

First and most importantly, term and universal life insurances offer protection for what’s most important to you.  The life insurance policy will carry a “face amount” death benefit.  This means that if you die while the policy is active or in force, the death benefits will be paid to your named beneficiary.  Your loved ones can then use those funds pay off a mortgage or other debt, pay estate or death taxes, compensate for the loss of income after your death, and pay final expenses associated with the funeral, burial, or cremation.  Or perhaps, you have other plans for how you would like to have that money spent.

For the most part, life insurance benefits are tax-free to the recipient, but there are some instances where a portion of the benefit will be taxed, such as in the case of universal life insurance policies.

The Differences

There are key differences to consider when choosing between term life and universal life insurances.  It is important to be aware of all of the differences so that you can ensure proper protection for your loved ones.

Length of Coverage

One of the most important things to consider when purchasing life insurance is the duration of coverage.  Term life insurance is virtually “renting” coverage for a predetermined or specified amount of time.  For example, if you purchase a 10-year term life insurance policy, your named beneficiaries will be paid your death benefit provided that you die during the policy term and you are in good standing with your premium payments.  However, if your death occurs after the policy term expires, your named beneficiaries will receive nothing.  There may be the option to renew your coverage for a higher premium amount at the end of your policy term.

Comparatively speaking, universal life insurance provides coverage over a longer period of time.  As long as the premiums required to keep the policy active are being paid, the policy could last until its maturity date.  This could be as high as 121 years of age, depending on the particular policy and carrier.

Young homeowners typically choose term life insurance for added assurance in the event of premature death in order to pay off an existing mortgage or to provide income replacement for your spouse in the event of your death.

If a longer-term insurance need is present, such as in providing estate liquidity for taxes, providing an inheritance for loved ones, or leaving a charitable legacy, then universal life insurance may be the more appropriate choice.

The Cost of Coverage

Understandably, term life insurance is more affordable than universal life insurance.  The reason is that term life insurance premiums only include the actual cost of insurance, and the policy is expected to be active for a specified period.  Furthermore, the insurance company adjusts the premiums according to the odds of the policyholder dying within the term of the policy.

Now, comparatively speaking, universal life insurance is more expensive than the term life option.  Rather than premiums only including the actual cost of insurance, universal life insurance premiums also include an amount that is credited to the policy’s “cash value.”  The cash value is an investment component of the insurance policy.  When you pay your universal life insurance premiums, if the actual cost of insurance is less than the cash value, then the surplus is added to the cash value.  The investment portion is credited with an interest rate that is competitive, as specified in the policy.  In the event that the premiums are not enough to cover the actual cost of insurance, the cash value is available to make up for the difference.

Due to the fact that the pricing of universal life insurance policies is based on projections of the cost of insurance and interest rates, it is important to monitor these policies over time in order to verify that the cash value is funded appropriately.  This will maintain that your policy remains active without the need to raise premiums in the future.  Your insurance agent or financial professional can assist you in understanding and reviewing policy options.

Flexibility

Term life insurance lacks flexibility.  If you do not pay your policy premium, the policy will be terminated, and your coverage will cease.

Conversely, universal life insurance is flexible due to the cash value portion of the policy.  This component offers flexibility by covering the cost of insurance in the event that the premiums are not paid by drawing from the cash value so that you are able to retain coverage.  The option is available to purposefully make more contribution to your cash value when making your premium payments.  The cash value component is a valuable resource within this policy.

Cash Value

As pointed out previously, the investment component of a universal life insurance policy allows for you to borrow or withdraw from the accumulated cash value within your policy.  When you decide to utilize a policy loan, you are ultimately borrowing from yourself, and paying yourself a competitive rate of interest when repaying the loan.

This feature of partially withdrawing from your cash value in order to cover for an unexpected expense is usually a better

alternative to getting a loan from a bank at much higher interest rates or using credit.

Keep in mind that using the accumulated cash value for loans or withdrawals can change the financial standing of the policy, so it is wise to repay loans as soon as possible in order to avoid surprise premium requirements in the future.

Alternatively, term life insurance does not offer the cash value component, so policyholders do not have the option to borrow from their policies.

Return of Premium

Considering term life insurance, once the policy term is met, the coverage expires.  The policyholder simply does not pay the premiums anymore, and they receive proof from the insurance company of having had coverage for the term of the policy.  There are some term life insurance policies that do offer an optional feature known as the “return of premium.”

The return of premium option means just that, the insurance carrier agrees to refund a portion, if not all of the policy premiums paid once the coverage term expired.  If this is an option, it is usually an automatic feature of the policy, or it is available as an optional rider, and there is typically a surcharge involved.  However, this option does make the term life insurance policy more appealing knowing that you will receive something at the end of the policy term if you survive.

Do Not Hesitate to Purchase Coverage

As with any life insurance policy, your premiums will be based largely on your age and health status at the time of application for coverage for both term life and universal life insurance policies.  Therefore, purchasing coverage while you are still young and relatively healthy is a wise decision.  If you wait too long, your premiums may be higher, and potential unexpected health issues may mean ineligibility.  By purchasing your life insurance now rather than later, you are making a thoughtful and practical decision for your loved ones by being prepared.