For most people who aren't in the insurance or financial services industry, trying to understand what different types of life insurance products are, and how they differ from one another, can be confusing. In this post, we'll review the similarities, and key differences, of two common types of life insurance: term life insurance and universal life insurance .
When you have a better understanding of how these products work, you will be able to make an informed decision about which type of life insurance will best meet your needs, and your budget.
Before we examine their differences, let's spend a moment reviewing the similarities between term and universal life insurance .
First and foremost, they both offer important protection for what's most important to you. Your life insurance policy has a "face amount" death benefit. If you die while the policy is in force, the insurance company will pay that death benefit to your named beneficiary(ies). Your loved ones can then use those funds to pay off a mortgage or other debts, pay your final expenses , pay estate or death taxes, help make up for the sudden loss of income that may occur when you die, or for whatever other purpose they want to use the proceeds.
Life insurance benefits are generally income tax free to the recipient, although there are some limited circumstances where a portion of the proceeds might be taxed for universal life policies; that's a topic for another day's life insurance blog post.
When you look under the hood, term insurance and universal life insurance are very different vehicles. Here are some of the key things to consider when choosing a type of life insurance to protect your loved ones:
One of the most important things to understand when you're buying life insurance is the duration of coverage.
When you purchase term life insurance , you are essentially renting coverage for a pre-defined period of time. If you have a ten-year term insurance policy, that means that, as long as you continue making your premium payments, the insurance company will pay the death benefit to your named beneficiaries if you die any time within the policy term. If your death occurs after the policy term expires, however, your loved ones will not receive anything. You may have the option of renewing coverage for higher premiums at the end of your policy term.
In contrast, universal life insurance is designed to provide coverage for a longer period of time. If enough premiums are paid to keep the policy in force, the policy could last until the policy's maturity date, which could be as high as age 121 (depending on the specific company and policy.)
Term life insurance is a popular choice for young homeowners who want to make sure funds would be available to pay off a mortgage in the event of premature death, or to provide for income replacement if one spouse was to die prematurely.
Universal life insurance may be more appropriate for a longer-term insurance need, such as providing estate liquidity for taxes, leaving a charitable legacy or providing an inheritance for loved ones.
As you might expect, term life insurance is cheaper than buying universal life coverage. That's because term life insurance premiums only include the cost of insurance, and the policy is only expected to be in force for a fixed period of time. The insurance company calculates the odds of the policy holder dying within the policy term when calculating premiums.
In contrast, universal life insurance is more expensive than term insurance. Instead of policy premiums simply representing the cost of insurance, universal life insurance premiums also include an amount that is credited to the policy's "cash value" account. Think of the cash value as a side fund that accumulates inside the insurance policy. When you pay premiums for universal life insurance, if the cost of insurance is less than the cash value, then the extra amount is added to the cash value. That side fund is credited with an interest rate that is usually competitive (specified in the policy.) If premiums are not enough to pay for the cost of insurance, then the cash value is there to make up the difference.
Because pricing for universal life insurance policies is based on projections about the cost of insurance and interest rates, it is important to watch these policies over time to make sure the cash value account is "funded" appropriately so the policy stays in force without the need to raise policy premiums in the future. Your insurance professional can help you review and understand policy illustrations.
Term insurance is inflexible; if you do not pay your policy premium, the policy will terminate and coverage will end.
In contrast, universal life insurance is a flexible type of policy. Because of the cash value component of the insurance policy, there is some flexibility if you are unable to make your full premium payments for a period of time. If premiums are not paid, the cost of insurance will be drawn from the cash value account so you retain coverage. You can also choose to intentionally pay more as extra cash value contributions with your premium payments, to accumulate a cushion within your policy.
One popular feature of universal life insurance policies is the ability to borrow from, or withdraw from, the accumulated cash value within your insurance policy. When you take a policy loan, you are borrowing from yourself, and paying a competitive rate of interest to yourself when you make loan repayments.
Taking a partial withdrawal or a loan from cash value to cover an unexpected expense can be an attractive alternative to borrowing from a bank at higher interest rates, or using a credit card for a large purchase. Of course, using the cash value for loans and withdrawals can change how "healthy" the policy is, so to avoid surprise premium requirements in the future, it's a good practice to repay loans as soon as possible and to not treat your life insurance policy as a piggy bank.
Because term life insurance does not have a cash value component, policy holders do not have the option of borrowing against, or withdrawing cash from, their policies.
Some term life insurance policies come with an optional feature known as "return of premium." With a traditional term life insurance policy, at the end of the policy term, the insurance coverage simply expires. The policy holder doesn't pay premiums any more, and does not receive anything from the insurance company (other than having had coverage for the term of the insurance policy.)
With return of premium policies, the insurance company agrees to refund part, or even sometimes all, of the policy premiums actually paid when the coverage term expires. Some policies automatically include this feature, while it is available as an optional rider with other policies. There is a surcharge for this option, but it can make renting coverage more attractive, knowing you'll get something in the end if you don't die during the policy term.
As with any type of life insurance, your premiums for both term life insurance and universal life insurance policies will be based in large part on your attained age and your health status when you complete an application for insurance coverage.
So, purchasing insurance while you are young and relatively healthy is a good idea, because your premiums will be lower than if you waited to buy life insurance. Of course, waiting too long could also mean that if some unanticipated health issue arises, you may not be eligible for coverage later.
It isn't fun to think about actually needing life insurance, but to paraphrase Benjamin Franklin: nothing is certain in life except for death and taxes. By purchasing life insurance, you are making a practical decision and giving the gift of pre-planning to your loved ones.
Whatever your insurance needs, you can count on the experienced, knowledgeable insurance professionals at Symmetry Financial Group to help protect what is most important to you.
We are different than many insurance firms and professionals who want to push their own proprietary products. We don't have our own products. Instead, we are a truly independent insurance broker, with access to insurance products from more than 30 high quality, trusted insurers - we represent many of the biggest names in the insurance industry today.
We will take the time to get to know you, and to find out what's most important to you, so we can tailor life insurance coverage to meet your specific needs, and your budget. We are never too busy to answer your questions or to explain policy features and options.
To learn more, and to start getting quotes for life insurance, contact Symmetry Financial Group today by completing our easy online contact form , or by calling (877) 285-5402.
