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What is the difference between whole life insurance and universal life insurance?

Nov. 9, 2007

Question:
What is the difference between whole life insurance and universal life insurance? Both types can last your whole life, right?

Jesse, New York

Answer:
Dear Jesse,

Yes, both "traditional" whole life insurance and universal life insurance policies offer insurance protection for your whole life. The differences lie in the way premiums are paid, how cash value accumulates, and how the death benefit is calculated.

In a traditional whole life insurance policy — also known as "ordinary life insurance" — the death benefit, premium payment schedule, and sometimes the interest rate for the accumulation of cash value are determined at the time the insurance contract is written, and are not subject to change.

The strengths of whole life policies, their consistency and guarantees, make them very rigid. You are locked into a set premium payment until the policy is paid up, and if your financial situation changes so that you can no longer pay the premiums, you may be faced with the unpleasant choices of using your cash value to pay for the insurance or surrendering the policy.

Universal life insurance policies, on the other hand, are designed to be more flexible, at the cost of the certainty afforded by whole life insurance.

With universal life insurance, neither the premium levels nor the death benefit is set in stone. Because the expenses of a universal life policy are tied directly to your death benefit, you are allowed to pay premiums for as much and as often as you choose. You will need to pay closer attention to your policies, however. While you are not necessarily required to pay any premiums every month, you need to make sure that you are able to pay a minimum amount each year or face having your death benefit reduced.

Also, if you are able to make increased payments and can show that you are still in good health, many universal life insurance policies will allow you to increase the amount of your death benefit.

You can also put excess money into your universal life policy to be held in a cash-value accumulation fund — jump-starting the accumulation of cash value that would accrue in a whole life policy. You'll usually get a minimum interest guarantee from the insurance company, but the actual performance of the fund is tied to insurance company investments. Because of this risk, your premiums can be lower than those of a whole life policy. If the investments perform well you may be able to skip premium payments altogether, instead of deferring them to the end of the year, if there's enough in your fund to cover your premium bill.

Also, with universal life insurance you have two choices as to how your death benefit and premiums will be calculated. You can choose a level death benefit — which would allow the insurance company to reduce your mortality expenses (and minimum premium payments) as your cash value increases — or you can choose to have your death benefit increase along with your cash value — keeping the expenses of the policy, and thus your minimum payment levels, steady.

In general, if you want more flexibility and are willing to devote the attention necessary to managing your premium payments, universal life insurance might be right for you. But if you are more comfortable with a monthly bill and an unwavering death benefit, then traditional whole life insurance might be more appropriate.

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Disclaimer: We are journalists, not financial planners or insurance brokers. Nothing we say should be interpreted as a recommendation to buy or sell any insurance product, or to provide other financial or legal advice.a

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