Universal life insurance vs. term life insurance: How do they compare?

When you're shopping for life insurance, it's important to understand the differences between the types. Two options are universal life insurance and term life insurance.

Like all life insurance, both universal and term life insurance contracts provide a death benefit to your beneficiaries at the end of your life. However, some key differences may make one or the other a better choice for you.

You might be asking: Is universal life insurance a term contract or a whole life contract? How does each type work? When should I choose one kind of life insurance over the other? You're not the only one with these questions. Here's an overview of universal life insurance vs. term life, and the key details to know.

As the name suggests, term life insurance contracts provide you with coverage for a defined period of time (term) as long as the premiums are paid. A term contract typically lasts 10, 15, 20 or 30 years.

Term life insurance does not accrue a cash value, and the premiums are often much lower compared to what you'd pay for permanent life insurance, which does have a cash value. Most of the time, contracts are issued with level death benefits, but you may be able to increase your death benefit at certain times if you have an increasing term contract.

Universal life insurance contracts provide coverage with flexible premiums. The contract stays in force as long as the contract maintains enough cash value to cover monthly deductions, which makes universal life insurance a type of permanent insurance. They also allow you to accumulate a cash value which can be accessed throughout the insured's lifetime to cover emergency expenses or even supplement retirement income.

For many life insurance contracts to remain in force, you must pay the premiums. Missing premiums can cause your contract to lapse and coverage to end. Flexible premiums allow you to vary the amount that you pay, which may be helpful if you have uneven income.

Term life premiums are not flexible, and you must pay the premiums in their entirety when due. Premium payments are typically paid monthly but sometimes are only paid once a year. If you miss the premium payment outlined in your contract and don't get caught up, the contract will lapse and your coverage will be terminated. Grace periods are typically 30 days. Term life insurance offers a guaranteed level premium during the level term period (10, 15, 20 or 30 years - determined when policy is issued).

The hallmark feature of universal life contracts is that they provide premium flexibility. Within certain limits outlined in your contract, you can increase or reduce the amount you pay each month. You may have to make up for reduced premiums over time, but the flexibility can be valuable if your income varies. Credited rates may change over time (never to go below a guaranteed rate established by the contract). If rates change, premiums may need to be adjusted to keep coverage in force.

Premiums paid into a universal life contract contribute to the policy's cash value and earn a fixed credited interest rate. Each month, deductions are taken from the cash value of the contract to cover contract fees and cost of insurance (COI) charges. Coverage remains in force as long as the cash surrender value is sufficient to cover the policy's monthly deductions. This design provides flexibility to the contract owner regarding the timing and amount of premium contributions.

Some life insurance contracts may accumulate a cash balance that you can access while living. When cash value is surrendered, the policy's death benefit is reduced by the amount of the cash distributed, dollar for dollar. You may be able to take loans (instead of a surrender) from the cash balance without incurring a tax liability, while withdrawals may have tax consequences. If you no longer wish to keep the contract, you can typically surrender it and keep the cash.

Term life insurance does not build a cash value. The premiums pay for insurance only.

Universal life insurance contracts accumulate cash value over time. A portion of each premium payment goes toward your cash balance, which can then grow. Your balance may grow according to a fixed interest rate in a universal life policy, or you may have the option of investing your balance into one or more investment subaccounts (only available in a variable universal life insurance policy). If you invest your money, its growth will be determined by the performance of the sub-accounts as outlined in your contract. This cash balance can also be used to help cover premiums.

Your coverage should last for as long as you need it to. Term life insurance contracts remain effective for a fixed period as long as premiums are paid, while universal life contracts can provide you with coverage for life.

When you buy term life insurance, your coverage will last for the duration of the period specified in your contract. Term life insurance can last for very short periods—such as a year—or may be effective for several decades. When the term ends, you may have the ability to renew or extend your contract, but there is no guarantee the premiums will stay the same or that you'll be approved.

You may also have the option of converting your term life insurance into a permanent life insurance if you purchase a convertible contract. This would allow you to continue with permanent life insurance during a predefined conversion window without getting a new medical exam.

Universal life insurance is a type of permanent insurance, which means it will remain in force for your entire life as long as the cash surrender value is sufficient to cover the policy's monthly deductions. As you get older, it typically becomes harder to qualify for life insurance. Owning permanent life insurance can help ensure that you will have coverage after you may no longer be eligible for term life insurance.

It's important that you understand the amount you'll pay for insurance and how that rate may change over time. Level premiums remain the same throughout the life of the contract.

When you get a quote for term life insurance, the rate that you are given will be the same for the duration of the contract. This can make it very easy to plan for your life insurance premiums in your budget.

Premiums for universal life insurance can be designed to be fixed, but may need to be adjusted to account for non-guaranteed elements of the policy. The cost of providing you with coverage will increase over the life of the contract as you age. While you will have premium flexibility, you'll need to make sure you cover the cost of the insurance to keep your coverage in place. You can do this by paying a higher premium or dipping into your accumulated cash balance. It's important to review your contract regularly to make sure the policy is healthy.

The amount and type of life insurance that is right for you depends on which features would benefit you most and why you want insurance in the first place.

If you only need coverage for a specified time period and want it to be as cost-effective as possible, then term life insurance may be best. If permanent life insurance that can last for your lifetime and provide a way to accumulate a cash balance with a flexible premium fits your needs better, then universal life may be the best choice.

A Thrivent financial advisor can help you review your financial situation and decide which option is the right for you.