Life Insurance Conversion: Understanding Policy Transformations

Life insurance conversion is the process of changing a term life insurance policy to a permanent one. This allows you to extend your life insurance coverage without needing a new medical exam. While term life insurance provides coverage for a specific period, permanent life insurance offers lifelong coverage as long as the premiums are paid. The conversion option may be included in the original contract or available by purchasing a special rider. It is important to note that not all term life insurance policies are convertible, and there may be deadlines for when the conversion can take place. Converting to a permanent policy typically results in higher premiums but provides benefits such as lifelong coverage, level premiums, and tax-free cash value accumulation.

What is the difference between term and permanent life insurance?

Life insurance is a way to provide financial protection for your loved ones after your death. There are two main types of life insurance: term and permanent.

Term life insurance is a simple and relatively inexpensive way to get life insurance coverage for a specified time period, such as 10, 20, or 30 years. If you die during the coverage period, your beneficiaries will receive a payout. Term life insurance policies do not build equity, and once the policy term ends, the coverage ends as well.

Permanent life insurance, on the other hand, provides lifelong coverage and does not expire as long as you continue to pay the premiums. In addition to providing a death benefit, permanent life insurance can also be a financial tool that helps you build wealth and accumulate cash value that can be used during your lifetime. The cash value of a permanent life insurance policy grows over time and can be accessed for various purposes, such as paying for college or supplementing retirement income.

One key difference between term and permanent life insurance is the cost. Term life insurance is typically more affordable, especially when purchased at a younger age. Permanent life insurance, on the other hand, tends to be more expensive due to the lifelong coverage and the ability to build cash value.

Another difference lies in the features and benefits offered by each type of policy. Term life insurance provides short-term death benefit protection, and some policies may include flexible features that allow early access to benefits in cases of terminal illness or disability. Permanent life insurance, on the other hand, offers long-term death benefit protection and the opportunity to build cash value.

The structure of premiums also differs between term and permanent life insurance. With term life insurance, premiums are typically level, meaning they remain the same throughout the coverage period. In contrast, permanent life insurance premiums may be structured differently depending on the specific type of permanent policy chosen. For example, with whole life insurance, premiums are locked in at the time of purchase and remain consistent. On the other hand, universal life insurance offers flexibility, allowing you to modify the premium and death benefit as your finances change.

When deciding between term and permanent life insurance, it's important to consider your financial goals, budget, and the needs of your loved ones. Term life insurance is suitable for those seeking short-term coverage or additional protection during specific times, such as when starting out or on a budget. Permanent life insurance, on the other hand, is ideal for those who need long-term financial protection, want to create an inheritance for their heirs, or prefer stable premiums.

How do you convert from term to permanent life insurance?

Converting from term life insurance to permanent life insurance can be done in four steps:

• Find your conversion deadline: Check your contract for the dates allowed for conversion. If you don't know the deadline, consult your contract documents or a financial advisor.
• Choose the type of permanent life insurance you want: The three types of permanent life insurance that are commonly available are whole, universal, or variable universal life insurance.
• Calculate the new policy cost: There is usually no direct cost to convert, but the premium payments will likely be higher. Consider a lower coverage amount if you want to keep premium amounts lower.
• Convert: Decide whether to do a partial or total conversion of your existing policy. A financial advisor will usually help with the paperwork. You will need to review and sign a new contract.

It is important to note that not all term life insurance is convertible, so check to see if your policy includes this option.

What are the pros and cons of converting?

Pros of Converting to Whole Life Insurance

• You gain lifelong coverage, which can help you transfer wealth to your loved ones.
• Your new whole life policy accrues cash value, which grows with interest over time.
• You avoid undergoing a new underwriting and health exam.

Cons of Converting to Whole Life Insurance

• Your new premiums may be higher.
• You may have a lower coverage amount.
• You may have to pay a one-time fee.

Pros of Converting to Universal Life Insurance

• You gain lifelong coverage, which can help you transfer wealth to your loved ones.
• Cash value earns interest.
• You gain premium payment flexibility.
• Estate planning possibilities may be more accessible.

Cons of Converting to Universal Life Insurance

• Higher cost than term life insurance.
• Cash value isn't as easy to access as your checking account.
• Flexible payments have limitations.
• Lower cash value growth rate.

Pros of Converting to Variable Universal Life Insurance

• You gain lifelong coverage, which can help you transfer wealth to your loved ones.
• Cash value with potential for greater gains or losses.
• Investment options give you choices for potential long-term growth.
• You gain premium payment flexibility.

Cons of Converting to Variable Universal Life Insurance

• Higher cost than term life insurance.
• More complex than term insurance.
• Cash value isn't as easy to access as your checking account.
• Investments involve risk.
• Flexible payments have limitations.

When is the best time to convert?

The best time to convert your term life insurance policy to a whole life insurance policy is when you can afford the premiums. Term life insurance is attractive for its affordable coverage, but if your budget has room for the more expensive whole life insurance, it might be time to convert.

Another good time to convert is when your health is declining. Whole life insurance premiums are typically higher if your health is poor, and you may even be rejected for coverage. Converting your term policy means you can skip the underwriting process, which usually includes a medical exam, and secure coverage without paying steep premiums due to your health.

If you are the primary breadwinner and are dealing with medical issues, converting to whole life insurance can give you peace of mind that your loved ones will be provided for when you pass away.

You may also want to consider converting when you want to cover final expenses. Even if you don't have dependents, your family will still need to cover your final expenses when you pass away. Converting your term policy to a whole life policy with a small death benefit could prevent your loved ones from having to take responsibility for these expenses.

If you are carrying debt, converting your term policy to whole life insurance might be a way to alleviate the stress of paying it off, as your family can use the death benefit to take care of your outstanding obligations.

Finally, you may want to convert when you want to build cash value. Unlike term policies, whole life insurance policies build cash value over time. Each time you make a premium payment, a portion of it is invested and grows tax-free. As the cash value on your policy accumulates, you can earn dividends and apply them to premium payments, use them to acquire more coverage, or access the funds if needed.

What are the alternatives to converting?

Alternatives to Converting Term Life Insurance to Whole Life Insurance

If you are considering alternatives to converting your term life insurance to whole life insurance, there are a few options to explore. Here are some alternatives to help you make an informed decision:

• Partial Conversion: This option allows you to convert only a portion of your term life policy to whole life insurance, resulting in a smaller death benefit and lower premiums. The remaining term policy stays active until its expiration date, which means you'll have two premiums to pay until the term policy ends. A partial conversion can be useful if you want to provide a smaller death benefit for your beneficiaries or if you want to avoid the high premiums of converting the entire policy to whole life insurance.
• New Term Life Policy: Instead of converting, you may consider purchasing a new term life insurance policy, especially if you only need coverage for a short additional period. While this option may require undergoing a new underwriting process and medical exam, it can be more affordable than paying the higher premiums of whole life insurance.
• Burial Insurance Policy: If your primary concern is covering end-of-life expenses, you might consider purchasing final expense insurance or burial insurance. This type of policy is designed specifically to cover funeral and burial costs and is generally the most affordable option.
• Renewing Your Term Policy: Many term life insurance policies offer the option to renew your coverage when the term ends. This can be a viable alternative to conversion, especially if your health has deteriorated or if your life expectancy has decreased significantly. However, keep in mind that renewing your term policy annually can lead to higher premiums over time.
• Laddering: This strategy involves purchasing multiple life insurance policies with different expiration dates to save money and get the coverage you need at the lowest price. By staggering the end dates of your policies, you can ensure continuous coverage while benefiting from lower premiums associated with shorter-term policies.

Frequently asked questions