Variable vs. Universal Life Insurance: What’s the Difference

If you have loved ones depending upon you, it can be a good idea to purchase life insurance. A life insurance policy pays a death benefit after you pass away. This can help your family pay off a mortgage, keep paying the bills once you’re no longer there to earn income, or pay for things such as a college education for your kids.

Some life insurance products do more than just pay a death benefit—they can help you invest. The policies that accrue a cash value that help you to build a nest egg are called permanent life insurance policies. There are different kinds of these permanent life insurance policies, including whole life insurance, variable life insurance, and universal life insurance.

While permanent life insurance policies are investment products as well as insurance products, there are some important differences between the kinds of permanent policies. Read on to learn about the differences between variable vs. universal life insurance to find out if either of these whole life products is right for you.

Understanding the Types of Life Insurance

There are two primary types of life insurance policies.

• Term life insurance policies: Term insurance policies are the cheapest way to get life insurance. These policies remain in effect for a limited time period, such as 30 years. Premiums are cheap because the policy does nothing but provide a death benefit if you pass away during the term. The low cost makes a term policy a good solution if you only need coverage while raising a family or saving money to make your family financially independent so they no longer rely on your income.
• Permanent life insurance policies: Permanent life insurance works differently because these policies build up a cash value you can access during your lifetime, either by selling the policy or taking a policy loan. The policy accrues a cash value because you pay higher premiums for coverage when you are younger than it actually costs to insure you. The money you pay grows tax-free, increasing the value of the policy.

Although there are some advantages to investing through a permanent life insurance policy, there are also downsides, including the fact that these policies can have high fees. You also need to understand how your money grows if you invest in a whole life, universal life, or variable life insurance policy.

Whole Life vs. Variable vs. Universal Life: What Are the Big Differences?

Whole life, variable life, and universal life all include investment options. They make investing easy because you pay your life insurance premiums and your money grows. But they aren’t the same. Here’s what you need to know about each policy.

Whole Life Insurance Policies

Whole life policies allow you to build up a cash value to access during your life, but your beneficiaries only receive the death benefit, so you’ll need to access the invested funds during your life if you don’t want to lose them.

There are different kinds of whole life coverage, including ordinary whole life coverage that has level premiums while you are alive and limited whole life insurance that covers you for life but allows you to pay premiums only for a designated time.

Whatever type you choose, your life insurance company typically invests the funds in a conservative investment on your behalf. You don’t need to decide what to invest in, and the policy will provide a guaranteed cash value account that grows based on the insurer’s formula, regardless of market performance.

Universal Life Insurance Policies

Like whole life policies, universal life policies pay a death benefit upon your death and accrue a cash value you can access during your life. Like with a universal life policy, your premiums are higher than the cost to insure you. As you pay these higher premiums, the extra money grows the cash value of the account. Then, each month, the money accrues interest, and all growth inside the plan happens tax-free.

However, universal life policies provide more flexibility than whole life policies because you can move your money around between the death benefit and the cash value. You could make your death benefit smaller and the cash value bigger or vice versa. You can only move money within designated limits set by your insurer, though, and universal life policies provide a guaranteed minimum death benefit.

Universal life policies accumulate their cash value based both on the premiums that are charged and based on current interest rates. You don’t have to choose what to invest in with these policies. And most policies offer a guaranteed minimum interest rate, so you never need to worry your money won’t grow as much as you planned, even if interest rates fall.

Variable Life Insurance Policies

Variable life insurance policies are permanent life insurance policies with a death benefit, just like universal and whole life policies. These policies also charge higher premiums than the cost of insuring you; the extra money from the premiums is invested, it grows tax-free, and the policy acquires a cash value.

But there’s a big difference. These policies provide the potential for more gains but expose you to more risk. That’s because, with a variable life policy, the money that has accrued in your policy is invested in different “sub-accounts.” These sub-accounts are similar to mutual funds but can only be purchased within the policy.

If the investments in your sub-accounts perform well, your policy could become worth much more than whole life or universal life policies. However, some insurers cap the potential amount of growth.

And, if investments perform poorly, it’s possible the value of your policy could go down. In fact, if your investments perform poorly enough, your premiums might actually need to rise so you’ll have enough money to invest in your sub-accounts.

Alternatively, a variable universal life insurance policy offers investment options and the flexible death benefits. With this type of life insurance product, you can get tax-deferred accumulations as well as tax-free benefits and access to cash. However, this product also carries no guarantees against the investment risks.

How Much Does Permanent Life Insurance Cost?

Insurance policy premiums for whole life, variable life, or universal life insurance can become expensive because these policies are designed to charge more than the cost of insuring you.

There are many factors that go into the cost of life insurance, including your age and health status. But the difference in premiums for permanent life insurance versus term life insurance is always substantial. For example, a healthy 35-year-old man who buys a 20-year term life insurance policy would pay around $430 annually to get a policy with a $500,000 death benefit while that same 35-year-old would pay around $4,400 annually for a universal life insurance policy.

While the higher premium payments for a permanent life insurance policy are partly explained by the fact that a portion of the premiums goes towards investing, some financial experts believe permanent life insurance costs more than it’s worth because of management fees and other costs insurers add.

Which Policy Is Right for You?

If you want a simple insurance policy to protect your family, a term life insurance policy is the cheapest and easiest way to get covered. But this policy will only cover you for a designated time, and it could be very expensive to buy continuing coverage when you’re older and the policy term expires.

A term life policy also doesn’t help you invest for the future—but you can set up an investment account on your own and potentially earn better returns than if you invest in permanent life insurance.

If you want the simplicity of getting insurance and an investment product all in one, a permanent life policy would be the better choice. Among permanent products, you may want to choose variable life insurance if you’re willing to take more risks to obtain potentially higher rewards. Or, you can opt for a universal life policy if you want guaranteed returns while still getting more flexibility than a whole life policy provides.

Ultimately, you’ll need to do your research carefully and consider all options to find the coverage that is right for you.