Updated on 10.03.16

Whole, Universal, and Term Life Insurance: What’s the Difference? What Do I Actually Need?

Trent Hamm

At some point in their lives, many people come to the conclusion that they need to have a life insurance policy. Perhaps you’re like me and that realization occurred when you first had children. Maybe some other life event occurred and caused you to consider it. Or perhaps you’re just following the advice from a personal finance book.

Whatever the reason, you’ve made the decision to buy life insurance. Now it’s time to look at the next step in the journey: figuring out what options are available to you and which one is best for you.

For starters, most life insurance packages tend to fall into one of three groups. You’ll find term life insurance, whole life insurance, and universal life insurance. Let’s look at them one at a time.

What is Term Life Insurance?

Term life insurance is the simplest form of life insurance to understand and it’s also the least expensive. When you buy a term life insurance policy, you sign up for insurance that will cover you for a particular term – a number of years, in other words. Over the course of that term, you’ll pay in a certain amount of money to the insurance company each year (or quarter or month, depending on your arrangement) – that money is called the premium. If you happen to die during the term, the person(s) you indicate as the beneficiary of your policy will receive the benefit of your policy.

So, for example, you might have a 20-year term life insurance policy that provides a $500,000 benefit to your spouse or to your children in the event of your death in that 20-year period. To maintain that insurance, you’ll have to pay in some amount each year. Although that premium is locked in for the length of your policy, it does vary a lot from person to person.

The biggest drawback of term policies is that if you live to the end of the term, you walk away with nothing. The policy only covers you for the number of years designated in your agreement at the start of the policy.

What is Whole Life Insurance?

Whole life insurance takes term insurance, gets rid of the “term,” and combines it with an investment package. Whole life insurance is a lifetime insurance package that offers a benefit upon your death to whoever you designate. Often, a whole life insurance package offers a certain minimum benefit, but that benefit might grow over time because a whole life insurance package also features an investment component.

Over the years, your policy begins to grow a cash value, which you’ll be able to borrow against later on if you so choose. You can even choose to receive dividends from that investment portion later on, though the dividends are usually small unless the insurance package is very large. Some people eventually start using the cash value of the insurance to directly pay the annual premium, meaning they have a policy that lasts for the rest of their life without any annual costs to them.

The catch for all of this is that the monthly or annual premiums – the amount you pay in each month or each year – are much, much higher than term insurance for the same benefit.

What is Universal Life Insurance?

Universal life insurance also lasts a lifetime, but it has the capacity to adjust the benefit later on. Universal insurance is actually very similar to whole life insurance, except that you have the capacity to adjust your benefit upwards or downwards later on depending on your changing insurance needs.

However, this comes with a cost. The premiums you pay also adjust with universal life insurance depending on current interest rates. The rates are typically much closer to the higher whole life rates than the term rates – in fact, universal life insurance rates are sometimes even higher than whole life insurance rates.

Isn’t the investment portion of whole and universal life insurance a great benefit? It can be, but you pay a lot for it. Your premiums are going to be much higher than they would be for a term policy.

Another big problem is that the investment portion of such policies is almost always very slow to grow at first. There are several reasons for that, but one of the big reasons in many cases is that during the initial years of such policies, some of your premiums are going to pay off the commission of the person who sold you the policy. That money cuts into how much can be contributed to the investment.

So what should you do? Here’s my advice.

How to Find the Right Life Insurance Policy

If you have no insurance right now and you’re an adult, get a term policy. Get one with a term long enough to cover your children reaching adulthood or until you expect that you’ll have enough assets that your spouse will be fine without you. I chose to get a 20-year policy, which covered the years until my children leave the nest, at which point the financial burden on my wife in the event of my death would be much smaller.

The reason here is simple. A term policy is going to be far less expensive than a whole life policy or a universal policy and you’re likely looking at this policy during a point in your life where your money is already being crunched hard. You’re likely facing student loans, a mortgage, the cost of children… I know how hard of a crunch all of that can be.

The thing you need to keep in mind is that you’re wanting this insurance mostly to cover you until that crunch period is over with. Ten years, 20 years, maybe at most 30 years from now, you won’t have that mortgage. You won’t have those kids to take care of. You won’t have those student loans. Your financial state will be much more stable.

If you currently have a whole life or universal policy that you’ve had for several years (or more), stick with that. At this point in the policy’s life, it’s built some level of cash value inside of it which can be a useful asset going forward. While the annual cost for the policy is higher than a similar term policy, you’ve already made it through the “rough years” with this policy, so stick with it.

What if you have kids? I genuinely do not think that most families need to purchase life insurance for their children, unless it’s a very tiny policy to cover funeral expenses. Remember, children do not have dependents, so the only thing that needs to be a concern if they pass on is their funeral costs.

Yet many people buy a universal or whole life policy for their children anyway. Why do that? There are actually a few reasons for it.

First of all, doing so serves as life insurance in case they do die young and thus alleviates funeral expenses for you. This is something that a term policy could handle anyway.

Second, buying such a policy when the person is a child means that you, as a parent, are the one that’s going to pay for the “rough years” of the policy where the cash value isn’t growing very fast. By the time you hand over the reins of the policy to them in adulthood, the cash value will be growing nicely and it will be a good deal for them to continue the policy.

There’s also the advantage of obtaining a policy before a long-term health problem would be exposed in the child, which would make it very difficult for them to get life insurance later on.

Are those reasons enough to get your child such a policy? It really depends on your financial state. If you’re struggling to make ends meet and keep the bills paid, I wouldn’t view such a policy as a priority, but if you are in a healthy financial state and spend significantly less than you earn, there are good reasons for making such a purchase.

So, what’s the next step?

Buying the Right Policy For Your Needs

If you’ve decided that a particular type of policy is right for you, spend some time independently figuring out how large of a policy you’d like to get. If you have dependents and are getting a term policy to care for them after your passing, you’ll probably want a term policy with a sizable benefit to ensure that those people in your life don’t suffer for your death. While it’s hard to figure out the “right” number here, I’ve found that this calculator at lifehappens.org has some pretty sensible results. Just put in the numbers that it calls for and it’ll give you a good estimate of how much life insurance you should get.

Once you have a benefit number in mind, consider how long you want the term to be. My suggestion is that if you’re a parent, you should get a term that covers all of the years until your children would graduate from college.

With those numbers in hand, start shopping around. Get quotes from several different insurance companies, then research those companies to find out how stable they are and how long of a history they have. For most policies, the state will step in to back up the policy if the company goes bankrupt, but for larger policies, you’re going to want to be very confident in the long-term health of the company.

Insurance salespeople will promote all kinds of products to you. Take them with a grain of salt. Keep your eye on the ball and keep it simple. Most of those extras that they’re promoting really have no value to you at all, no matter how sweet they make them sound.

Good luck!

To find the best policy for your needs, it’s crucial to shop around. Make sure to compare policies and offers before you settle on a policy that will adequately protect your family.

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