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Whole Life vs. Universal Life Insurance

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Jen Smith
Updated August 3, 2022
4 Min Read

An insurance that many people need but few have is life insurance. For most, term life insurance is sufficient to fill this need, but if you’re a high income earner looking to preserve your wealth long-term, you may want to look into permanent life insurance.

While not a substitute for traditional investment accounts, permanent life insurance has benefits that can help high net worth individuals protect their wealth and pass down more to their family. The two main types of permanent permanent policies you’ll have to choose between are whole life vs. universal life insurance.

Unlike term insurance, which guarantees a death benefit payout only during a specified period, whole and universal life policies provide coverage for life. And if you cancel either policy before you die, you will receive the policy's cash value, minus any fees.

What is Universal Life Insurance?

Universal life insurance, also known as adjustable life, is a type of permanent life insurance that offers affordable premiums and flexibility. With this type of policy you can adjust the death benefit when needed, increase it, or lower it to reduce premium costs. You can also use the cash value portion to pay premiums as long as there’s enough money in the account to do so.

The purpose behind the creation of universal life insurance was to attract customers in the 1980’s who were choosing to invest in the stock market for it’s high returns versus buying life insurance for it’s guaranteed, but lower, return. Nowadays, it’s rare to see the double digit short-term interest rates that were the norm then but variations of universal life still aim to make it the policy that best capitalizes on market returns.

But with the potential of higher reward comes higher risk. When the market doesn’t make the returns predicted when the policy is purchased, your premium will increase and you’ll either have to pay more each month or deduct from the cash value of the investment portion to pay the gap.

There are several types of universal life insurance. Traditional universal invests your cash and gives you a set return determined by the insurer. Indexed universal life insurance tracks the rate of an index, typically the S&P 500, and variable universal life insurance allows you to pick from a set of mutual funds and manage them yourself. According to LIMRA, variable life insurance held 11% market share in the second quarter of 2021. This is the highest market share for VUL since 2008.

What is Whole Life Insurance?

With a whole life insurance policy, your premiums, rate of return on cash value and death benefit, as long as you pay your premium, are all fixed and guaranteed. Because of the guarantee, whole life insurance is the most expensive type of life insurance, and it gets more expensive the later in life a policy is started.

Unlike a universal life policy your premium will never increase and returns aren’t tied to performance of the market. The insurance company keeps premiums the same by charging a price that, at first, is higher than what’s needed to pay claims. It invests that money then uses it to supplement later premiums and subsidize the cost of life insurance for older policyholders. 

When these “overpayments” reach a certain amount, insurance companies are required by law to make them available to the policyholder as a cash value if he or she decides not to continue with the policy. Like universal life insurance, cash-value accumulates tax-deferred and the death benefit is tax-free.

According to LIMRA, whole life represented 36% of the U.S. life insurance market in the second quarter of 2021

Differences Between Whole Life And Universal Life Insurance

While similar on the surface, the key differences between whole life and universal life insurance will have a major impact on who they’re best for.

Whole life is designed for consistency over returns. Premiums will never increase but you also can’t decrease them if your circumstances change. Universal life is built for flexibility. You can change your death benefit or premium based on your situation but that can also work against you if the market doesn’t perform as well as anticipated.

Finally, whole life is “set it and forget it” while universal life requires you to monitor your policy. You’ll need to monitor the actual cash value inside the policy, at least once a year, against the illustration you received when you bought it. If the numbers line up then you’re on track. If they don’t and the value of your cash account is less than what was predicted then you should plan for increased premiums or lapse in coverage. Failure to do this could result in surprise expenses or, at worst, losing your policy altogether.

Which is Better? 

It’s important to point out that while both whole life and universal life insurance have a cash account that increases in value, neither are considered a good substitute for investing. Before considering a permanent life policy you should be able to max out your retirement accounts and have an additional portfolio of diversified investments. Until you’re able to do that, a term life insurance policy is probably fine for you.

Beyond that, whole life is a great option if you want a guaranteed lifelong return and don’t care about maximizing returns in your life insurance policy. Remember that whole life is the most expensive life insurance option and often takes over a decade to begin to show a noticeable increase in cash value. 

If you’d prefer to get higher returns and don’t mind increased risk or the possibility of increased premiums, then a universal life policy could be better for you. Remember that past performance in the market is no guarantee of future returns and any returns you do see will be diminished by ongoing, and sometimes increasing, fees associated with the policy.

In the whole life vs. universal life insurance debate, the winner is whatever policy makes you feel best about preserving your wealth. And if you’re not in a place yet to truly benefit from permanent life insurance there’s always term life insurance.