Term vs. Universal Life Insurance: What’s the Difference?

Life insurance provides you with a tool to financially help protect your loved ones and, in some cases, move toward your financial goals. Although there are many policy types, two popular options are Term and Universal life insurance. These have different features and benefits, suiting different policyholders. Furthermore, there are several sub-types of each policy that let you customize coverage based on your needs. Let’s dive deeper into how each policy type works and compare their features to help you determine the right option for you and your beneficiaries.

How does Term Life Insurance work? 

Term Life Insurance offers coverage for a fixed period from 10 to 30 years, depending on your preferences. Therefore, you may need to renew or get new coverage once your policy expires. Premiums are lower to account for your risk of outliving the policy. There are several kinds of Term Life Insurance policies:

Level Term Life Insurance 

Level Term Life Insurance has premiums that don’t change for the duration of the policy. This predictability can make it easier to build premium payments into your budget.

Yearly Renewable Term Life Insurance 

Yearly Renewable Term Life Insurance lasts for one year. It allows you to renew coverage annually without additional underwriting or a new medical exam. However, premiums will increase each year.¹ This makes yearly Renewable term life insurance a more flexible option for policyholders who don’t need to lock in many years of coverage. For example, you may only need life insurance for special circumstances that may increase risk, such as travel.

Return of Premium Life Insurance 

Return of Premium Life Insurance refunds your premiums paid if you outlive the policy term. However, premiums tend to be higher than Level Term Life Insurance to account for the chance of outliving the policy.² Additionally, if the policy lapses due to non-payment or policy cancellation, you may be disqualified from receiving a refund of premium payments. Overall, Return of Premium life insurance may work if you’re confident you’ll outlive your policy but want peace of mind.

How does Universal life insurance work? 

Universal life insurance is a flexible Permanent life insurance policy offering lifelong coverage. It may also come with a cash value growth component that earns interest at a specific rate depending on the type of policy you have. As the cash value grows, you can cash out some or all of the policy in several ways, including taking out a policy loan, withdrawing funds, and surrendering the policy.

Furthermore, Universal Life Insurance offers flexible premiums and death benefits. You can raise your death benefit through a premium increase or reduce your premiums by agreeing to a smaller death benefit. Several types of Universal life insurance exist, including:

Traditional Universal Life insurance

Traditional Universal Life Insurance offers lifelong coverage, along with flexible premiums and death benefits. The cash value grows at a fixed rate the insurer specifies. This policy is a good option for those seeking coverage flexibility and slower but safe wealth-building.

Guaranteed Universal Life Insurance

Guaranteed Universal Life Insurance offers fixed premiums that are lower than other universal policies. The difference is that this policy typically has little cash value.³ It’s designed for people who need lifelong coverage at more affordable rates than Traditional Permanent Life Insurance policies and don’t need an additional wealth-building vehicle.

Indexed Universal Life Insurance

Indexed Universal Life Insurance offers the same features as traditional universal life insurance. However, you can invest part of your cash value in a fund that tracks an index, such as the S&P 500 stock market index. The other part remains in a standard, interest-bearing account. This adds some investment risk if the index the fund tracks decreases. However, it could also lead to higher potential returns if the securities in the index perform well. Overall, an Indexed Universal Policy could provide a middle ground between Traditional and Variable Universal Life Insurance.

Variable Universal Life Insurance

Variable Universal Life Insurance works like Indexed Universal Life Insurance, but you can invest your cash value into various mutual funds across different investment accounts. These mutual funds may consist of stocks, bonds, or other assets. This could offer the fastest potential cash value growth if the investments perform well, potentially helping you take advantage of your cash value earlier.

However, there is a greater risk of losses should the investments perform poorly. If your cash value drops too low, your death benefit could decrease, or your policy could lapse. Therefore, these policies may work best for those with higher risk preferences or who feel confident managing their own investment selection.