When you begin to (compare life insurance) policies, you may feel overwhelmed by the sheer number of choices available. Unlike in past decades, today’s life insurance policies offer a wide variety of features in addition to a standard death benefit. Some types of policies, such as universal life policies, can be particularly complex.
If you ask an agent about buying a universal life policy, she may ask if you are interested in traditional or variable universal life. Both types of policies are similar; however, there are important differences.
Similarities Between Universal Life and Variable Life
Both traditional universal life and variable life, like all life insurance policies, feature a stated death benefit. If you die before the policy expires, your beneficiary will receive the death benefit amount. This feature is important for protecting your loved ones against financial struggles they might otherwise face if you are no longer alive to earn income. You typically choose the stated death benefit amount when you purchase your policy. Some policies allow you to increase or decrease the death benefit as your circumstances change.
Cash value accumulation is another feature of traditional universal and variable life. When you start the policy, it will have no cash value; however, as you continue to pay premiums, the cash value increases over time. The cash value might also increase if it earns interest based on investments the policy tracks. The better the investments perform, the more quickly your cash value will grow.
Both types of policies provide you with access to your cash value after your policy has been in force for a certain amount of time. You can access the cash value through a policy loan – this helps you avoid paying taxes unless you fail to repay the loan. You can also withdraw cash value from your policy; however, you will typically incur income tax on the portion of the withdrawal attributable to interest gains.
Traditional and universal life insurance policies also typically contain provisions that allow you to use a portion of the accumulated cash value to pay the death benefit portion of your premiums. This feature can be advantageous because, if you encounter financial difficulties later in life, you can use the cash value to keep your policy in force and retain financial protection for your loved ones. Of course, you can only use this provision to pay your premiums until the cash value in your policy is exhausted.
Differences between Traditional and Variable Universal Life
The primary difference between traditional universal life and variable universal life policies lies in the manner in which these policies earn interest on the cash value. Traditional universal life policies typically track a major index, which determines the interest rate these policies earn. Typically, policy provisions establish a maximum interest percentage rate per year, which means that your potential earnings are capped. In most cases, though, there is no financial downside – you cannot lose previous years’ earnings or paid-in premiums.
Variable universal life offers greater flexibility when it comes to choosing the investments that determine the interest rate your cash value earns. Maximum interest rates, if any, are typically higher than for traditional universal life policies.
With variable universal life, there is also an earnings downside. If the investments or markets you choose decline in value, you may lose interest gained during previous years. You might even lose some or all of the paid-in premiums used to build cash value. This could affect your ability to borrow or withdraw money from your cash value to take care of future expenses or meet future financial needs. Although this type of policy offers higher upside potential than traditional universal life, the substantial downside risk makes some consumers hesitant to purchase variable universal life policies.
Choosing a life insurance policy to meet your family’s needs is a complex process and should be taken seriously. Choosing the wrong kind of policy for your individual situation can compromise your finances down the road and can even leave your loved ones without the level of protection they need. After you (compare life insurance) policies, you should talk to a financial adviser or licensed insurance agent to determine which kind of policy is right for you.
