Whole life insurance vs. IUL: Main differences, pros & cons, cost

Whole life insurance vs. indexed universal life insurance

Whole life insurance and indexed universal life insurance (IUL) are two types of permanent life insurance that will cover you for the rest of your life and come with a cash value account you can borrow from while you’re alive. But there are some key differences between both to consider. 

With a whole life insurance policy, your cash value will grow at a fixed rate from the time your coverage begins until you die. With an IUL policy, your cash value account’s growth will be attached to a stock market index, though it isn't a form of investment in the stock market. This means IUL has a higher growth potential — but also a higher risk. IUL policies also require more involvement because you can’t let the cash value account fall below zero if the stock value drops.

Whole life vs. IUL: An overview

What is whole life insurance?

Whole life insurance is a type of permanent life insurance that lasts for your entire life. You’ll make premium payments, and no matter when you die, your loved ones will receive a guaranteed payout — known as the death benefit. Whole life also includes a tax-deferred savings account from which you can borrow cash while you’re alive. This cash value earns interest at a fixed rate set by the insurer.

Whole life insurance is significantly more expensive than a comparable term life insurance policy because it comes with a cash value account and lifelong coverage. Whole life policies are less expensive than an IUL policy but also offer less flexibility. 

Learn more about term vs. whole life insurance

Pros & cons

Pros

• Whole life insurance lasts for the rest of your life. You don’t have to worry about your coverage expiring. This feature can be especially helpful if you have dependents that require lifelong care. 

• Whole life earns interest through its cash value component. If you’re already maximizing your contributions to retirement accounts like a Roth IRA or a 401(k) and are seeking another investment option, a whole life policy can help you complement your investment portfolio. 

• You can benefit from your policy’s cash value while you’re alive. Withdrawing money or taking out a loan from your cash value is easier and less expensive than taking out a personal loan.

Cons

• Whole life is significantly more expensive than term life. If you take out a whole life policy and then find you can’t afford to keep it, you’ll lose your coverage and lose all the money you paid in premiums. 

• If you cancel your policy during the surrender period, you might have to pay extra fees — unlike term life insurance, which has no penalty for canceling. 

• Whole life has lower rates of return compared to other investment options, like a 401k or IRA. 

• You have to keep paying for most whole life policies every year to keep them active. If you aren’t able to pay, you’ll lose your coverage. 

• If you borrow money from your policy’s cash value and die before you pay it back, your policy will pay out less than the total death benefit amount. 

What is indexed universal life insurance (IUL)?

Indexed universal life insurance (IUL) is a type of permanent life insurance policy that will never expire. As long as you make your payments, your policy will remain active. IUL policies have a cash value account that earns interest based on a stock market index, such as the S&P 500®. With IUL, you may be able to use the cash value to cover your premiums and even adjust your death benefit amount.

IUL policies may offer higher growth potential than other permanent insurance options, but they’re also more expensive and harder to manage. This type of policy is best for high-net-worth individuals looking to diversify their investments and the means to monitor a more complex life policy. 

Pros & cons

Pros

• IUL offers more cash value growth potential than other permanent policies. 

• IUL can help pay off large estate costs or pass a tax-free inheritance if your assets are big enough to trigger estate taxes.

• IUL offers a lot of flexibility. You’ll have a flexible death benefit and premium payment plan if needed, which means you can increase or decrease the size of the payout as your coverage needs change — and you can even use the cash value you’ve accumulated to pay your premiums. 

Cons

• There’s a lot more risk associated with an IUL than with other life insurance products. If the stock index doesn’t perform well, you’ll have to pay more into your policy to prevent it from lapsing — and maintaining those payments can become expensive.

• The earnings may be capped. For example, if the S&P 500 earns 7% but your policy is capped at 4%, you won’t see the full growth reflected in your cash value, and you may have been better off investing that money directly in the market. 

• IUL policies don’t take into account dividend yields, which creates another situation in which the growth rate credited wouldn’t match the index growth — dividends are usually paid out quarterly or annually to the policyholder if the insurance company overperforms financially. 

• Using your cash value may come with taxes, restrictions, and fees in certain scenarios. You’ll have to be cautious about complying with these policy rules to maximize your financial gains. 

What are the main differences between IUL & whole life insurance?

While whole life insurance and IUL both offer lifelong coverage, there are strong differences between the two types of policies to consider before you purchase either. 

Death benefit

With a whole life insurance policy, the death benefit is fixed. The only way the insurer would reduce the death benefit amount to pay your beneficiary is if you take out a loan against the cash value and pass away before you can pay it back. In this case, the insurer will deduct the amount owed from the total death benefit and leave your loved ones the rest. 

With an IUL, you have some flexibility with the death benefit. If your cash value account grows enough, you can add this amount to the death benefit total and leave your beneficiary more than the amount you initially agreed upon with the insurer. 

Cash value accumulation

With a whole life policy, your cash value amount will grow at a fixed rate determined in your policy. It will usually be a small, yet consistent rate of growth. 

The growth for the cash value of an IUL policy is based on a stock market index. If the stock performs well, your cash value may grow faster, and if the stock doesn’t perform well, your cash value may grow more slowly — or perhaps not at all. If you feel more comfortable navigating the stock market, an IUL policy could be a better fit for you. 

Cost & premiums

Both types of policies will cost significantly more than a comparable term life insurance policy, but IULs will tend to be more expensive than a whole life insurance policy. However, you can use the flexibility of an IUL policy in your favor to offset its cost without the risk of reducing the death benefit. 

With an IUL, as the cash value grows, you can use it to pay your premiums. But this does require more administrative oversight and a hands-on investment approach, as you’ll need to monitor the total of the cash value to make sure it doesn’t drop below zero. 

Who should consider whole life insurance?

Whole life insurance is best for people who want a guaranteed death benefit and are able to commit to paying the required premiums, usually for the rest of their lives. This often includes people who have lifelong financial obligations, like an adult dependent or large amounts of debt. 

Who should consider indexed universal life insurance?

IUL is best for people who are savvy enough to take advantage of the flexibility this policy will offer and able to pay the higher premiums. With an IUL policy, you’ll need to be able to monitor the amount of your cash value and potentially adjust the premiums you pay as the cash value fluctuates. 

How to decide between whole life & IUL

• If you’re trying to decide between a whole life policy and IUL, the best thing you can do is determine if you can benefit from the flexibility that IUL provides. 

• If you have the bandwidth to monitor how the cash value grows and optimize its changing value by adjusting your premiums or even the death benefit, an IUL policy can be worth the extra cost for you. If you would prefer a policy that offers lifelong coverage with a set amount for your premiums and death benefit, that requires little maintenance, a whole life policy will be a better fit for you.