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Whole Life Insurance vs. Universal Life Insurance

Whole life insurance or universal life insurance–which form is better? What are the major differences between whole life insurance and universal life insurance? Is whole life insurance cheaper than universal life insurance?

There are many questions surrounding whole life insurance and universal life insurance. Luckily, this article will help clear up some of those questions and help you better understand the differences between whole life insurance and universal life insurance.

Whole Life Insurance

Under a whole life insurance policy, the purchaser agrees to pay premiums to a life insurance company in exchange for a guarantee of a specified benefit payable to their spouse or other beneficiaries upon their death. Earnings on a whole life insurance policy are set by the life insurance company based on the overall return on its investments. Earnings above and beyond those required to cover the death benefit go to the policy’s cash reserve, which you can borrow against, use to pay premiums, or allow it to accumulate for long-term goals such as retirement.

Universal Life Insurance

Universal life insurance policies allow the purchaser to set the premium and the death benefit. As such, it lets people establish a permanent policy with a lower premium than they would have to pay under a whole life policy. Under whole life insurance, premiums are set by the insurance company based on long-term interest rates and actuarial tables predicting the period of time over which the premiums will be paid.

Whole Life Insurance vs. Universal Life Insurance

The flexibility provided by universal life insurance policies is attractive. Also, higher interest rates mean money doesn’t have to work as hard to generate the same return. As a result, universal life insurance premiums are typically lower during periods of high interest rates than whole life insurance premiums for the same amount of coverage. And, while the interest paid on universal life insurance is often adjusted monthly, interest on a whole life insurance policy is adjusted annually. This means that during periods of rising interest rates, universal life insurance policy holders see their cash values increase much more rapidly than those in whole life insurance policies.

How Interest Rates Factor In

Interest rates, in this case, are a double-edged sword. As with any attractive option, there is an associated risk. In this case, you are betting long-term interest rates will remain where they were when you bought the policy. If rates fall significantly after you purchase the policy, the odds are good that the premium stream won’t cover the cost of keeping the universal life insurance policy in force and maintaining the death benefit payable sometime in the future.

If the worst case scenario occurs and interest rates drop (as they have since the 1970s), it is likely the premiums paid on the universal life insurance policy will need to be increased to generate enough income to cover the projected cost of the death benefit. If premiums do fall short, the policy could eventually lapse – becoming completely worthless. While your agent should make it very clear to you that you are running into a situation where this might happen, letting a life insurance policy lapse you have been paying into for years is a significant potential drawback. This is something that will never happen with whole life insurance.

Once you have figured out your life insurance needs, it is then time to decide if a whole life insurance or universal life insurance policy is best for you. It is always important to make sure you get the coverage you need at a price you can afford.

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