Life insurance is a popular financial tool you can use to support your family, plan for the future or prepare for the unexpected. You have several insurance types to consider, including term life insurance and universal life insurance. While both insurance types provide financial protection, they have different purposes to match different situations and goals.
Term life insurance offers financial protection for a set number of years. Universal life insurance provides financial protection for a lifetime and accumulates cash value. It's important to understand how each works, so you can choose the best policy to match your financial goals. Learn about each insurance type, their pros and cons and when to choose universal life insurance vs. term life insurance.
What is the difference between term and universal life insurance?
Term life insurance and universal life insurance differ in several ways, such as whether or not they can accumulate cash value. Key differences between the two insurance types include:
| Term life insurance | Universal life insurance | |
|---|---|---|
| Cost | Lower | Higher |
| Coverage length | Limited to a set period, such as 10, 20 or 30 years | For the insured's lifetime as long as premiums are paid |
| Cash value | None | Accumulated |
| Flexibility after issue | None | Adjustable premium and death benefit amounts |
| Suitability | Young families, budget-minded individuals and families or those with specific coverage term length needs | Individuals with more complex financial goals or lifelong coverage needs |
What is term life insurance?
Term life insurance is temporary, meaning you have coverage for a set number of years. The term length is often based on specific life circumstances, such as having a baby or buying a new home. This coverage provides a death benefit to beneficiaries if the insured passes away during the policy term. This type of insurance is for a fixed period, like 10, 20 or 30 years, and premiums are typically more affordable than other insurance types.
How term life insurance works
If you're wondering "how does term life insurance work?" it's simple and straightforward. You'll pay the same premiums for the duration of your policy. If you pass away during this time, your family will receive a death benefit.
Term life insurance will not accumulate cash value, so if you're living when the policy expires, you will not receive any refunds of paid premiums. For these reasons, term insurance has lower premiums than other options, making it a cost-effective choice for young families and those who need coverage on a budget.
There are a few different types of term life insurance, such as level term and return of premium. Level term policies guarantee that the death benefit and premium payments stay the same through the entire policy term. Return of premium policies refund premiums you've paid throughout the term length if you're living when the policy expires. These premiums will generally be higher than level term policy premiums.
Pros of term life insurance
Term life insurance is a good option for families who want financial security but may not want to or be able to fit higher premiums into their budgets. The pros of term life insurance include:
- Affordable premiums
- Simple and straightforward
- High coverage amounts
Cons of term life insurance
Term life insurance may not be the best option for some people's specific financial goals or needs. The cons of term life insurance include:
- Policy expiration
- No cash value
- Premiums rise with age
What is universal life insurance?
Universal life insurance is permanent, meaning your coverage can last up to a lifetime while also accumulating cash value. This type of insurance offers flexible premiums, cash value growth and doesn't expire. Universal life insurance is a popular option for people who have more complex financial situations or goals, such as planning ahead for college tuition, retirement or leaving a legacy.
How universal life insurance works
Universal life insurance doesn't have an expiration date and offers greater flexibility for both premiums and death benefits. As long as you continue to pay premiums, your policy will remain in force for as long as you need. You can raise or lower your coverage amounts if your circumstances change throughout the policy.
Universal life insurance also comes with built-in cash value that earns interest tax-deferred for as long as you have the policy. You can use the cash value to cover premiums, borrow against or fund other expenses.
Pros of universal life insurance
Universal life insurance is a popular choice for people who are interested in creating security for their family while planning ahead. The pros of universal life insurance include:
- Coverage can last a lifetime
- Cash value growth
- Flexibility
Cons of universal life insurance
Universal life insurance may not be the ideal choice for everyone depending on their financial situation or long-term planning needs. The cons of universal life insurance include:
- Higher premiums
- Complex policies
- More exposure to risk
Which life insurance policy is right for you?
When considering universal life insurance vs. term life insurance, it may be beneficial to think about the financial loss your family would experience if you passed away. Do you want your children to be financially supported as they grow up? Do you want to plan for retirement or leave an inheritance? Do you want to make sure any debts or end-of-life expenses don't burden your loved ones? The right insurance policy is the one that best fits your specific life circumstances, budget and long-term needs.
When to choose term life insurance
Term life insurance is beneficial for certain situations where you need affordable coverage for a limited amount of time. This makes it an ideal option for young families or budget-minded individuals who want the security of a larger death benefit and lower premiums. Term life insurance is also a good choice if you only need temporary financial protection, such as for the length of a mortgage or while children are in college.
If you already have group term life insurance through your employer, you still may want to consider a term life insurance policy. Generally, you can't transfer this type of insurance to a new job. If you aren't sure what your career will bring in the next few decades, term life insurance can provide the protection you need for as long as you need, regardless of where you work. If you find yourself in a transition period, such as between jobs, short-term life insurance can provide coverage for that small amount of time.
When to choose universal life insurance
Universal life insurance is beneficial for more complicated goals that go beyond a basic death benefit. This makes it a good option for those who have estate planning, wealth transfer or lifetime financial protection goals. Universal life insurance is also a good choice if you want more flexibility in your premium payments and death benefit amounts, which can be beneficial if your income changes during the years your policy is active.
When to consider multiple life insurance policies
You may find yourself in a situation where your coverage needs and financial goals don't fit into one policy type or another. Combining multiple life insurance policies helps make sure you can meet these short-term and long-term financial needs. This can help you take advantage of the specific benefits of each insurance type while paying a monthly premium that still fits within your budget.
For example, you may want affordable protection for your young family now but also plan for future financial goals, such as retirement or legacy planning. If you need a $500,000 death benefit, you can blend a $250,000 term life insurance policy and a $250,000 universal life insurance policy.
You'll get higher levels of coverage during the years you may experience bigger life changes, such as a mortgage or children. At the term policy's expiration, you'll still have a universal policy that has been accumulating cash value and covers remaining lifetime needs. You'll have the flexibility to increase or lower your premium payments if your income fluctuates later in life.
Frequently asked questions about term and universal life insurance
What happens when a term life policy ends? If your term life insurance policy expires while you're still living, your premium payments and coverage will end. Your beneficiaries will not receive a death benefit and you won't be refunded for the premiums you've paid. At this time, you can renew or convert your existing policy or purchase a new one.
Can you convert term life insurance to universal life? It depends on your specific policy, but many term life insurance policies have a conversion option. This option lets you move to a permanent life insurance policy without providing proof of insurability, such as taking a medical exam or completing a health questionnaire. Conversion options generally have an expiration date, such as once a certain age or term length is reached.
Is universal life insurance worth the cost? Whether you feel a universal life insurance policy is worth it depends on your needs. Universal life insurance can have higher premiums than term life insurance and fluctuating interest rates can affect its cash value. However, as a permanent type of insurance, it will provide financial protection that won't expire. Ultimately, knowing your specific coverage needs, financial goals and risk tolerance can help you decide if universal life insurance is a good option for you.
How does the cash value of universal life insurance work? Each time you pay a premium, part of this payment will go to administrative and insurance costs. The remaining amount goes to a cash value account. This money earns interest generally at the market rate. Over time, this cash value accumulates and can be used to help pay a mortgage or supplement college tuition, retirement income and more.
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