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

Two of the most common types of life insurance are term life and universal life, and each has its own unique advantages and disadvantages.

The main differences are that term life insurance has more affordable premium payments and a set end date, where as universal life insurance premiums are significantly more expensive, but they last for the life of the policyholder. Universal life insurance also has a cash value component that policyholders can access for other uses.

Learn about the differences between these two types of life insurance in more detail so you can choose which one would work best for your needs.

How Term Life Insurance Works

Term life is the most basic type of life insurance policy. It provides coverage for a specific period of time. If you maintain premium monthly or annual payments, which are generally more affordable than permanent policies, your beneficiaries will receive a payment if you die before the term ends. Some policies include coverage for dismemberment and additional coverage for accidental death.

After a specified number of years — typically 10, 20, or 30 years — term insurance policies expire. However, some insurers allow you to continuation the policy, typically at a higher rate. Or you can sometimes convert a term policy into a permanent policy, which has no expiration date.

Term life insurance is often offered as an employee benefit. If you’re shopping for a policy on your own, check the AM Best financial strength rating to make sure you’re dealing with a reputable company. You can also review Investopedia’s annual list of the best term life insurance companies.

How Universal Life Insurance Works

Universal life insurance is a type of permanent life insurance, or cash value insurance. Like all life insurance, these type of insurance policies have a death benefit that is paid to beneficiaries when the policy holder dies, but unlike term life they last for the life of the owner.

Universal life insurance also has a savings component, or cash value, that builds up over time on a tax-deferred basis. You can often access the cash value such as through a life insurance policy loan and use the money toward other expenses.

Universal life insurance policies are designed to last until the policyholder’s death, and you are usually subject to penalties if you terminate the policy early.

During the initial years of the policy, a large portion of the premiums paid by the policyholder will go toward the savings component. During the later years, when the policyholder is older and the cost of insuring them is higher, more of each premium will go toward the cost of insuring them and less into savings.

Example of How Term and Universal Life Insurance Differs

With term insurance, rates tend to increase as you age whereas universal life insurance premiums remain the same. For example, if a 21-year-old buys term insurance, their premium might be $20 per month for a certain amount of coverage.

With a universal policy, the 21-year-old might pay $100 a month for the same amount of coverage, with $20 going toward death benefits and the remaining $80 toward savings.

When the person reaches age 45, term insurance might cost $50 per month, while universal life would still cost $100 per month, although a lower portion of that amount would go into the cash savings component and more would be used to compensate for increased risk.

Special Considerations

Term life insurance is appropriate for the average person looking to insure themselves and their loved ones against unforeseen events. That is especially true for young families on a budget, in part because for the same amount of money they can buy a much larger term policy.

The fact that term insurance eventually ends may fit some people’s needs. For example, parents of children who are grown and financially independent may no longer need life insurance.

However, term life is not necessarily the best choice for everyone. For example, individuals who would benefit from the tax advantages of permanent insurance may be less concerned with the higher costs of those plans.

The Bottom Line

Term and universal life insurance both have unique pros and cons to consider. Keep differences such as premium costs and term lengths in mind when you determine which policy may be right for you. For more personalized guidance, consult a professional financial advisor who can guide you through how each policy would fit into your personal financial situation.