Permanent life insurance is an invaluable resource to safeguard your family, and it is important to establish a plan to support your loved ones when you die.
Whole Life Insurance and Index Universal Life Insurance are two of the most common types of permanent life insurance available. These policies provide your beneficiaries with a payout that they can use for funeral arrangements or personal expenses. However, there are key differences between the two policies.
Before finalizing any contract, you should understand how each insurance policy works and its associated benefits and risks. After all, a permanent life insurance policy is a serious long-term commitment. Getting it right the first time is important because canceling an active policy could incur hefty charges.
In this article, I’ll explain the key differences between Index Universal Life Insurance and Whole Life Insurance to help you decide which policy is right for you.
What Is Whole Life Insurance?
Whole Life Insurance is the most basic form of permanent life insurance. It’s also called traditional life insurance because it was the original policy created for those who wanted to receive death benefits.
In exchange for a fixed premium, the Whole Life Insurance policy guarantees that your family receives funds to cover expenses after your death. It also provides a cash savings component that compounds at a fixed rate according to your policy terms. You can access the accumulated cash through a loan or consecutive withdrawals.
Whole Life Insurance offers a designated death benefit value at the beginning of your policy. Therefore, you can rest assured that your beneficiaries will receive the funds indicated in your contract. This is why many advisors consider Whole Life to be the safest type of permanent life insurance available.
However, your insurance provider has the right to deduct any withdrawn or borrowed cash value amounts from the initial death benefit. Cash value deductions are typical for any permanent life insurance policy.
Pros and Cons of Whole Life Insurance
Here is an overview of the main advantages and disadvantages of applying for a Whole Life Insurance policy:
Pros of Whole Life Insurance
- Fixed premium for the policy’s duration*
- Conditionally secured death benefit amount to beneficiaries**
- Tax-free compound interest on cash savings
- You can use the cash savings while you’re still alive
- Option to pay the policy in full and avoid monthly premiums (only applies to some policies)
Cons of Whole Life Insurance
- Low and unstable interest rates may hinder cash savings growth
- Deductible loan balances/withdrawal amounts will decrease death benefits
*Fixed premiums can be both advantageous and disadvantageous. On one hand, fixed payments allow you to plan your finances according to your policy’s schedule. However, it leaves little room for flexibility. Adjustable payment options may come in handy during tough financial periods. For example, lowering your premiums could give you access to a few extra dollars to cover your family’s needs.
**Your beneficiaries will only receive the full death benefit if you haven’t spent money from the cash savings account. Otherwise, your insurance provider will deduct the cash spent from the benefit, and your heirs will receive the balance.
What Is Index Universal Life Insurance?
Index Universal Life Insurance allows you to earn interest from part of your premiums (the balance from your monthly insurance costs) based on the performance of a stock market index. All interest you receive from your policy goes toward a usable cash value account. You’re free to use the accrued cash to take a loan or cover emergency expenses.
As with other permanent life insurance policies, your insurance company will subtract any borrowed cash value from the death benefits granted to your beneficiaries.
Index Universal Life Insurance Pros and Cons
Index Universal Life Insurance is still relatively new to the financial industry. But its earnings potential makes it a lucrative option for certain policyholders.
Here’s a summary of the pros and cons you should consider before applying for this type of permanent life insurance:
Pros of Index Universal Life Insurance
- Flexible premiums to accommodate changes in your budget
- Conditionally secured death benefit amount to beneficiaries**
- Potentially great investment earnings
- Tax-free interest on investment profits
- You can use the cash savings while you’re still alive
- 0% investment floor safeguards against financial losses during market downturns
Cons of Index Universal Life Insurance
- Expensive premiums
- Investment earnings depend on stock market index performance
- Deductible loan balances/withdrawal amounts will decrease death benefits**
Similarities Between Index Universal Life Insurance and Whole Life Insurance
Permanent life insurance policies share a few general characteristics.
Primarily, most permanent life insurance providers have rigorous application guidelines. Your eligibility for coverage and the cost of your premiums depend on factors like age, sex, health history, driving record, and occupation. Ultimately, insurance companies seek to filter “high-risk” applicants and buy themselves time before having to release another lump sum of death benefits.
Whole Life Insurance policies include a cash savings account that you can access for personal or business purposes. Likewise, Index Universal Life Insurance has a cash value component, accrued by premium investment returns, which the policyholder can draw and borrow from. Those usable funds can be a lifesaver during unexpected emergencies, especially for retirees who’ve already maxed out their Roth IRAs.
The cash savings from Whole Life Insurance compound at a fixed interest rate. Although Index Universal Life Insurance interest rates may vary, companies usually place a cap on your earnings to regulate the amount of profit going toward your cash value.
Perhaps the most beneficial similarity between the two policies is that your cash earnings and death benefits are tax-free.
What is the Difference Between Index Universal Life Insurance and Whole Life Insurance?
While Index Universal Life Insurance and Whole Life Insurance allow you to secure funds for your family and earn real-time cash, their terms vary.
Whole Life Insurance policies have fixed premiums that are easy to track throughout your policy. But you might appreciate the potential to adjust your premiums when you need extra cash—that’s only possible with an Index Universal Life Insurance policy.
Of course, higher death benefits equate to higher premiums. So you’d need to decrease your benefits to lower your scheduled payment amounts. Not everyone feels comfortable using that avenue. The good news is that saving money is not your only option. You could also temporarily suspend your payments and use your accumulated cash value earnings to pay for your coverage.
Whole Life Insurance is generally less rewarding than Index Universal Life Insurance. With a Whole Life policy, you might earn only about 4% interest, whereas the Index Universal Life policies cap allows you to earn up to approximately 12%.
However, policyholders hoping to take loans on equity index earnings from their insurance policy need to be vigilant with their earnings. The 0% floor may protect you from losing any money during marketing downturns, but it also means you won’t be earning anything throughout that period. Ensure that you can still afford to cover your debt out-of-pocket should your investment earnings hit a wall.
Which Permanent Life Insurance Policy is Better?
Index Universal Life Insurance and Whole Life Insurance offer earning potential while covering your after-death expenses. But the best insurance policy for you depends on your long-term financial goals.
A Whole Life Insurance Policy may be ideal for you if:
- You prefer to receive fixed-rate earnings
- You want a guarantee that your premiums won’t increase later on
- You want a more affordable permanent life insurance policy
However, you may be better off with an Index Universal Life Insurance Policy if:
- You want flexible premiums
- You hope to invest with the potential for higher earnings
- You don’t feel threatened by the risk of investments
Insurance can be complex to understand without the guidance of a financial advisor or policy expert. Need help figuring out which permanent life insurance policy is best for you? Sign up for a free consultation now so we can discuss your insurance needs and find the best plan for your financial goals.