Pros and Cons of Converting Term to Whole Life Insurance

The term life insurance you secured when your children were young plays a pivotal role in your financial protection, offering financial security at a cost-effective rate. But, these policies are intentionally designed for short-term coverage. If you outlive the policy’s duration, your beneficiaries receive no death benefit.

Term insurance might suffice for your family’s needs. But, if there’s been a shift in your earnings, financial goals, or health, you might be able to convert your term insurance into a permanent life insurance (such as whole life or universal life insurance).

A key incentive to switch to permanent coverage is the potential for policyholders to build cash value, which can assist with retirement or other long-term financial objectives.

  • Deciding between keeping term insurance and converting to whole life is dependent on the needs of the policy holder
  • Some Term life policies can be converted to whole life insurance policies
  • Considering life events and health changes as you weigh the pros and cons of converting, what is right for you today may not be right for you tomorrow

Permanent life insurance assures a death benefit for your heirs as long as the policy remains active, not just for a predefined period. Many individuals approaching retirement opt for permanent policies. They offer a means to handle final expenses, bolster financial security for a surviving partner, or establish a monetary legacy for their offspring or grandchildren.

While individual financial circumstances vary, permanent life insurance often serves as an effective long-term strategy. Many choose term insurance in their earlier years due to financial constraints. Yet, as their financial situation evolves, converting the policy becomes a viable option.

Converting to a permanent policy, like whole life or universal life, is generally more expensive. Premiums for whole life insurance are commonly 10 times more than those for term life insurance with an identical death benefit, but you can often build some solid cash values in return. This is because permanent insurance offers lifelong coverage with set premiums. The actual premium amount will be contingent on personal factors.

Before converting your term life policy into a whole life policy, you should understand the pros and cons of the conversion.

Relying on insights from a knowledgeable financial professional is important. They can assist in making informed decisions, preventing unsuitable choices.

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Considering a term to whole life conversion? Here are the top five questions to ask:

Can term life policies be converted?

Many term life insurance policies offer a conversion feature that lets policyholders convert to a permanent policy during its tenure. There’s also usually the choice to prolong the term, though premiums tend to spike.

It’s common for insurance companies  to levy a slightly elevated premium for conversion eligibility. Some companies may provide a discount on the premium for the new policy in its inaugural year, helping mitigate the conversion’s upfront costs.

Conversion clauses in term life policies aren’t uniform; they vary by the specific product and insurance company. Each comes with its own set of rules and cutoff dates. Some policies might let policyholders convert anytime before the term concludes, while others might only offer a window, like the initial 10 years. There might also be age caps in place, such as only permitting conversions up until 75 years of age. Lengthy conversion durations can inflate the costs. When opting for a term policy, it’s crucial to look over the conversion features and the subsequent policies into which it can be converted.

Review your term policy to understand its conditions or work with a financial expert for advice.

Who shouldn’t consider conversion?

Switching from term insurance to permanent insurance isn’t always the best choice, particularly if you desire some extra coverage only during your family’s most financially challenging times.

There’s a belief that certain individuals might not even require life insurance (be it term or permanent) if they possess substantial assets and savings, ensuring their family won’t undergo financial turmoil should the main breadwinner pass away suddenly. such situations aren’t commonplace. It’s hard to  truly ascertain your financial readiness without predicting potential future challenges.

If the premium costs of a permanent policy with equivalent death benefit coverage are burdensome, retaining some of your term insurance may be prudent. While term insurance might be more cost-effective for the same coverage amount, it only disburses benefits if the policyholder passes away while the policy is still active..

There are instances where individuals lean towards the long-lasting assurance of a permanent policy but require a heftier death benefit than their budget permits. In these scenarios, term life insurance, providing a larger death benefit at a fraction of the cost, is often a good option in combination with some permanent coverage. Ultimately, it boils down to financial flexibility.

Assessing the pros and cons of conversion also entails factoring in income consistency. If there’s apprehension about maintaining the higher premiums of a permanent policy due to potential income disruptions, keeping more coverage in the form of term insurance, which usually has lesser premiums, might be a safer bet. It’s essential to note, non-payment of premiums leads to policy termination, which eliminates a death benefit.

Who stands to gain from converting from term to permanent insurance?

Permanent insurance is often viewed as a mechanism to afford a base level of coverage for final expenses, assist a remaining partner, or bestow a financial inheritance to heirs. It presents solutions for unforeseen costs, such as those stemming from health emergencies or unexpected home repairs, as well as for sustained financial burdens like university fees or lingering debts. Using cash values by borrowing or making partial withdrawals will decrease the policy’s available cash value and net death benefit.. 

Switching from term to permanent could be a wise choice if you:

  • Aim to give assets to your descendants, yet want the flexibility to utilize your retirement savings.
  • Have undergone a divorce and want a guarantee that a share of your wealth will be allocated to your direct offspring through a death benefit upon your passing.
  • Belong to a high-income bracket and are looking to potentially shrink your taxable estate by moving your life insurance into a trust. It’s essential to note that trusts are intricate instruments necessitating the proficiency of a legal expert.
  • Have experienced a negative health event that will keep you from buying permanent insurance directly – or from getting new coverage with a good health rating. (more below)

There’s a multitude of benefits to owning permanent life insurance beyond the mere death benefit with tax efficiency being paramount.

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In essence, life insurance boasts a threefold tax boon. The cash value grows on a tax-deferred basis, you can retrieve the cash value without tax implications (up to the cost basis – the cumulative amount spent on policy premiums), and the death benefit is typically disbursed to your beneficiaries devoid of income tax. 

Did my health take a turn?

Conversion is a good option if your health has changed and you are no longer insurable.. Examples of such health changes could be receiving a diagnosis for conditions like heart disease, diabetes, or cancer.

An advantage of conversion is that policyholders won’t be denied a permanent policy based on changes in their health, as long as the conversion occurs within the window permitted by the term policy.

Such situations highlight the practicality of conversion. If an individual receives, for instance, a cancer or terminal diagnosis, or somehow anticipates a reduced life span, they could potentially convert to a permanent policy, ensuring a guaranteed death benefit for their loved ones.

It’s crucial to remember that conversion rights in term policies might not span the policy’s entire duration. Hence, if a terminal condition is identified late into the term, conversion might not be available.

Is partial conversion a possibility?

For those considering transitioning their term policy into a permanent policy  but find the premiums steep, a partial conversion might be an option, if the insurance provider permits it. Here, only a segment of the original term life policy transitions into a permanent policy.

Policyholders could convert a portion, like 20% of their term policy, every couple of years in tandem with their increasing income.

In a decade, they’d hold a fully-fledged permanent policy. There are instances when term life insurance initially emerges as the sole feasible choice due to restricted finances. Yet, with a convertible feature, one can gradually transition it into permanent coverage. Note: Often partial term conversions must be done in $100,000 increments.

For numerous growing families, term life insurance stands as an important safety blanket, granting financial security against the potential loss of life & income at the cheapest rate in the short-term. But as finances change, especially those who face health challenges or have long-term objectives, should contemplate the pros and cons of converting from term insurance to permanent insurance, or at least getting some permanent coverage along with their term insurance sooner than later.

Term policies with conversion opportunities grant more flexibility.

Term Life vs Whole Life

Both term life insurance and whole life insurance have their distinct advantages tailored to specific life circumstances and financial stages. The potential to convert from a term policy to a permanent policy offers policyholders flexibility, acting as a safety net when life throws unexpected curves, particularly concerning health or changing financial needs. While term insurance provides an affordable safety net during vulnerable financial periods, permanent insurance caters to building mid-term liquidity, as well as long-term planning and legacy goals. 

Ultimately, the decision to convert rests on individual needs, financial health, and long-term objectives. Seeking guidance from a financial professional and understanding your conversion rights can help you make the best decisions for your financial situation. 

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  • Term Life Insurance: Secured for financial protection, especially when children are young. Term policies offer short-term coverage at cost-effective rates. Most term policies never pay a death benefit due their skyrocketing premiums after the level period ends.
  • Conversion to Permanent Life Insurance: Given shifts in earnings, financial goals, or health, transitioning from term insurance to permanent insurance (typically whole life) ensures continuous coverage.
  • Benefits of Permanent Coverage: It allows policyholders to build cash value for major purchases or investments during their life, and build assets for retirement or other long-term objectives along with a guaranteed death benefit as long as the policy is active.
  • Financial Considerations: Many initially choose term insurance due to financial constraints, but as their situation evolves, conversion becomes a feasible option.
  • Premium Costs: Transitioning to a permanent policy is generally more expensive initially.The cost is largely based on individual factors.
  • Conversion Features: Many term policies offer the option to convert to permanent policy, but conversion features vary between insurance companies.
  • Conversion Decisions: Converting isn’t always the best strategy, especially if someone is still insurable and can apply for a new permanent policy. Financial stability and long-term planning are factors in this decision.

Ben McFieBen T. McFie

There's a lot of confusion around finance; there's so much to know and it's frustrating when you don't know enough to make the best financial decisions. I like to bring clarity to financial matters so people can make good financial decisions that will help them live wealthier more fulfilling lives.