Life Insurance: Conversion Credit Explained

Life insurance policy conversions take place daily, and conversion credits are an integral part of the process. Term life insurance policies usually offer the option to convert them into permanent life insurance policies. This is called a conversion privilege, and it allows the insured to switch to another policy without submitting to a physical examination. Conversion credits are premium reductions offered in response to the significant price hike for the permanent policy. Typically, the discounted premiums last for just the first year of the conversion, but they can make a substantial difference in cost.

What is a conversion credit?

A conversion credit is a premium reduction offered by some life insurance companies to offset the significant price hike that comes with converting a term policy to a permanent one. Typically, the discounted premiums last for just the first year of your conversion, but some companies may do it differently, crediting you with a percentage of the premiums you've paid.

If you're considering a partial conversion of your policy, your conversion credit will be reduced.

When can you convert term to whole life or other permanent coverage?

The deadline for converting a term life insurance policy to a whole life insurance policy depends on the insurance company and the specific policy. Some policies have a built-in conversion clause, while others require the purchase of a rider. The conversion period is typically before the end of the term, with deadlines outlined in the policy. Some policies allow conversion at any point before the term expires, while others specify a time frame, such as the first 10 years. Age restrictions may also apply, with conversions only permitted up to a certain age, commonly 75.

It is important to note that not all term life insurance policies are convertible, and some insurance providers offer non-convertible policies designed to provide temporary coverage at a lower cost. Therefore, it is essential to review the policy documents or consult with the insurance provider to determine if and when conversion is possible.

In addition to whole life insurance, other types of permanent life insurance policies include universal life insurance and variable life insurance. The availability of these options for conversion may vary depending on the insurance company and the specific term life insurance policy.

How do you convert from term to permanent life insurance?

Converting from term life insurance to permanent life insurance is a straightforward process, but it's important to understand the implications and whether it's the right move for your circumstances. Here's a step-by-step guide on how to convert from term to permanent life insurance:

Step 1: Check Your Policy for a Conversion Option

Not all term life insurance policies offer the ability to convert to permanent life insurance. Review your policy documents to see if conversion is included. If you're unsure, contact your insurance agent or company to clarify. It's worth noting that even if conversion is allowed, there may be specific limitations or deadlines, so be sure to understand the details of your policy.

Step 2: Understand the Conversion Period

If your policy does offer a conversion option, the next step is to identify the term conversion period. This is the timeframe during which you are allowed to convert your term policy. Some companies allow policyholders to convert at any point during the term, while others may limit the conversion period. For example, you may only be able to convert during the first 10 years of a 20-year term policy. Make sure you know the deadline to ensure you don't miss the opportunity to convert.

Step 3: Evaluate Your Reasons for Converting

Converting from term to permanent life insurance is a significant decision, and it's essential to understand your motivations. Ask yourself why you want to make this change. Common reasons for converting include changes in health, budget, or financial goals. Permanent life insurance can provide lifelong coverage, build cash value, and help with estate planning. Consider seeking guidance from a financial professional to ensure you make an informed decision.

Step 4: Contact Your Insurance Company

Once you've confirmed that conversion is an available option and you understand the reasons behind your decision, it's time to reach out to your insurance company. Discuss the permanent life insurance products they offer for conversion. Understand the different types of permanent policies available, such as whole life, universal life, or variable life insurance, and the benefits and costs associated with each.

Step 5: Choose the Amount to Convert

You may not need to convert your entire term life policy to permanent coverage. Consider how much coverage you require and whether a partial conversion would suffice. Converting only a portion of your term policy can help manage the increased costs associated with permanent life insurance. Additionally, if you convert just a part of your term policy, the premium on the remaining term policy will typically decrease due to the reduced benefit.

Step 6: Complete the Necessary Paperwork

The final step in the conversion process is to fill out the required application or conversion form provided by your insurance company. Unlike purchasing a new policy, you won't need to undergo a medical examination or go through the underwriting process again. Your health status won't affect the rates for your converted policy, but your age at the time of conversion will impact the premiums. Submit the completed paperwork to your insurance company, and they will issue your new permanent life insurance policy.

What type of permanent life insurance should you choose?

Permanent life insurance policies are designed to last a lifetime and are more expensive than term life insurance policies. They are, however, a good option for anyone who wants lifelong coverage and a cash value component. Here are some of the types of permanent life insurance policies available:

Whole Life Insurance

Whole life insurance is the most common type of permanent life insurance. It offers a guaranteed death benefit, and premiums never change. Whole life insurance policies also build cash value that grows at a guaranteed fixed rate and may be eligible to receive annual dividends. This type of policy is a good option for those who want more guarantees.

Universal Life Insurance

Universal life insurance is a good option for those who want more flexibility. Premium payments can be adjusted over time, which can be beneficial if you need to pay for other large expenses. However, this may negatively impact the cash value of the plan, and premiums could eventually go up over time. Universal life insurance typically offers lower premiums and more flexibility than whole life insurance but weaker guarantees and cash value growth potential.

Variable Universal Life Insurance

Variable universal life insurance has flexible premiums and a savings component. The savings portion, or cash value, grows based on the investment methods that you choose. There is usually a minimum and maximum growth rate, offering more risk but also more reward potential.

Indexed Universal Life Insurance

The second type of universal life insurance is indexed universal life insurance. This type of policy has the same basic parts as a permanent life insurance policy, but the cash value grows based on a chosen stock market index. If the chosen index is performing well, the account will grow. If not, some companies allow it to grow at a minimum rate.

When choosing a permanent life insurance policy, it is important to consider your unique needs and financial goals. It is also recommended to work with a financial professional to help you choose the right policy and optimize your coverage.

What are the pros and cons of converting term to whole life insurance?

Converting a term life insurance policy into a whole life insurance policy can be a good idea for some, but not for others. Here are some pros and cons to help you decide if it's the right move for you.

Pros

• Lifelong death benefit: Whole life insurance policies offer coverage for the entirety of the policyholder's life, rather than for a fixed term. This means that, as long as the required premiums are paid, the policyholder's family will receive a death benefit.
• Guaranteed cash value growth: Whole life insurance policies guarantee the growth of the policy's cash value over time, and this growth is not affected by market volatility. This makes the long-term value of life insurance cash value a unique part of a comprehensive financial plan.
• Tax advantages: The death benefit from a life insurance policy is generally passed on to heirs tax-free. Additionally, the policyholder can access the policy's cash value in a tax-advantaged way while they are alive, which can help manage tax payments during retirement.
• No health exam required: Converting a term life insurance policy into a whole life insurance policy does not require the policyholder to undergo a health examination. This is especially beneficial for those whose health has deteriorated since taking out the original term life insurance policy, as it allows them to avoid higher rates or being denied coverage altogether.
• Keep your original risk class: When converting a term life insurance policy to a whole life insurance policy, the policyholder gets to keep their original risk class assignment.
• Build cash value: A portion of permanent insurance premiums goes into a cash value account that accumulates interest. The policyholder can access low-interest loans against this amount during their lifetime.

Cons

• Higher premiums: Whole life insurance policies are far more expensive than term life insurance policies. Even though the added benefits are usually worth the additional cost, it is possible that the policyholder is not in a position to shoulder the expense.
• Age affects premiums: While the policyholder's health will not impact the cost of a new whole life insurance policy, their age will. The older the policyholder, the higher the premiums will be.
• Limited policy options: Not all term life insurance policies can be converted into whole life insurance policies. The availability of conversion options depends on the insurance company and the specific term life insurance policy.
• Must convert during the conversion period: The conversion privilege will likely have an expiration date, meaning the policyholder has until then to convert to a whole life insurance policy.
• Healthy individuals may find better rates elsewhere: If the policyholder is still in good health, they may be able to find a more competitive rate by shopping around for a new policy, rather than converting their existing term life insurance policy.

Frequently asked questions