Term vs. Whole
Term life insurance only lasts for a certain amount of time. During that period, you will usually have a level premium which is guaranteed not to rise. The death benefit will also remain constant if something were to happen to the insured.
Upon completion of the level premium period, term life insurance will either rise dramatically in cost, until it eventually expires completely, or end entirely right away.
Term life insurance is designed to cover someone when they likely need the protection most, at a lower cost. For example, young families with small children and a mortgage have a strong need for coverage. If something were to happen to either parent, but especially the breadwinner, or breadwinners, the family may be left with enormous expenses that they may find themselves unable to cover.
If one were to purchase a term policy while they are young and healthy, their premiums should be relatively low. Once their mortgage is paid off, children have moved out of the house, and they have successfully funded their retirement accounts, in a perfect world, there should no longer be a need for life insurance protection.
Unfortunately, for many, life doesn’t always go according to plan. People will often refinance their mortgages, thus requiring them to pay for longer than expected. You may also move and need to purchase a new home. Children don’t always land on their own two feet, and may move back home upon completion of their education. While you may have intended to fund your 401k to the max, due to rising costs of living and inflation, that may not be enough. How much more so, if the funds were needed for daily expenses and not saved for the future.
To combat the need for insurance at a later point in life, when a person’s mortality rate is significantly higher, there is permanent life insurance. More specifically, universal and whole life insurance policies. There are many types of each policy, however, the basic premise is that the insurance will last as long as you do.
As can be expected, the cost of permanent coverage is drastically higher than a term policy. However, there are usually other features besides for the death benefit coverage that may make these policies more viable.
Upon completion of a term life insurance policy, an insured will either have to pay significantly higher premiums, purchase a new policy, or be uninsured.
The issue with purchasing a new policy is that you will now need to requalify on a health and financial basis. Chances are your health is not the same as it used to be and a new policy will be more expensive. Not to mention the difference in cost simply due to the age difference, which alone is extremely significant.
There is another option, which is referred to as conversion or switching from term to whole life insurance. While this is not a magic pill, it can be very lucrative. The idea of conversion is that you are guaranteed insurability. When you convert your term life insurance to whole life, there will be no health or financial questions whatsoever. All you will need to do is a bit of paperwork and start paying the new whole or universal life insurance premiums. From that point forward your policy will last forever and may build cash value as well, depending on the exact policy specifications.
Your new permanent policy will be priced based on the health class that the original term policy was issued at.
How Does Conversion of a Term Policy Work?
Generally, there are 2 types of conversion available in the market:
- Original age term conversion
- Attained age term conversion
Original Age Term Conversion
This option is very rarely done. It allows for converting the policy based on not only the health class, but also the original policy purchase age. It is a great option as it provides you with a policy that is already thriving. However there are two downsides.
First, it often makes the policy into a MEC (Modified Endowment Contract) and thus it loses a lot of its tax benefits.
Second, and the main reason why this option is seldomly selected, it requires back paying all the premiums, as if the policy had been purchased at the original purchase date of the term policy, plus interest.
If you purchased a term policy in 2011 and in 2021 decide to convert it at your original age, the following equation would be made:
- How much did you pay into the term policy so far?
- What would the premiums have been, had you started your whole life policy 10 years ago?
- What interest rate would be charged?
As you might assume, this can equal an astronomical sum. Though, there is a silver lining to this option. You do have the full cash value as if your policy started on the original date of your term purchase. You can, therefore, take loans and withdrawals right away. One strategy is to actually use the money in the cash value to pay for the missing premiums.
Attained Age Term Conversion
The main benefit of this option is that you are not questioned regarding your health whatsoever. So, if you qualified for the best health class when you originally purchased your term policy, even if your health has deteriorated significantly, you will still get a permanent policy based on your initial health category.
A lot of people keep this option as a “Plan B” so that, if toward the end of their term, they see that requalifying for a new term policy at decent rates would be unlikely, they will instead convert or upgrade the term into a Whole life policy.
Many purchase Term Life Insurance with the intention of switching it into a whole life policy down the road as well.
When Should I Convert My Term Life Insurance to Whole Life?
Most companies allow for conversion of Term policies into Whole or Universal Life from day one. There are some companies who require waiting a year, but that is not typical.
The ability to convert expires at varying stages depending on the company and policy. Some offer the privilege until a set age at, for example, 65 or 70. Others place the limitation on policy years such as five or 10 years into the policy. Many companies allow you to extend this right by purchasing a rider for a nominal monthly amount.
You do not, and probably shouldn’t, wait until your term policy is about to expire to look into the conversion options available on your policy, as the option may expire or, at the very least, cost more in the later policy years. It should be a discussion you have with your advisor while purchasing your term policy. At Sproutt Life Insurance, we can advise on the various nuances and differences between the companies and their conversion limitations.
Can a term life insurance policy be converted to whole life?
Yes, most life insurance companies do offer this ability.
Can I convert my whole life insurance to term life insurance?
No, conversion refers to switching a term policy into whole life and not vice versa.
Does it make sense to convert term life insurance?
That would depend on your health and finances, but it may be very lucrative for many.
How much does it cost to convert term to whole life?
The actual conversion is free. However, upon converting a policy, the premiums will most likely rise significantly, being that the new policy will have a lot more benefits and features.
Is it worth converting term to whole life?
Depending on your personal situation, it may very likely be a good idea. Reach out to an advisor at Sproutt Life Insurance to walk you through the various pros and cons for a complete picture.
Should I convert my term life insurance to permanent?
If you can afford the new premiums, it probably makes sense.
What are the benefits of a convertible and renewable term life insurance policy?
Convertible term, aside from offering a death benefit while the policy is inforce, allows for the ability to convert the policy into whole or universal life.
Renewable term life insurance starts at the lowest possible cost but may rise sharply. Here is more information on both term options.
What can a convertible term insurance be converted to?
Depending on the insurance company, any or all of the following permanent life insurance options:
- Whole Life
- Guaranteed Universal Life
- Index Universal Life
- Variable Universal Life
- (Traditional) Universal Life
What does it mean to convert a term life insurance policy to permanent?
It means upgrading your term policy to a permanent policy based on your original health rating.
What is a conversion option on a term life insurance policy?
It allows for the upgrade of a term policy to a permanent policy without the need to requalify.