Pros and cons of converting term life to whole life

This article will ... Help you understand the cost difference between term and permanent life insurance. Explain how converting from term to permanent life insurance coverage may help you lock in lifelong protection even if your health has changed.  Explore scenarios in which converting term to whole life insurance might potentially make financial sense.  .

That term life insurance you bought when your kids were young is an important part of your financial safety net, providing maximum income protection at an affordable price. But it does come with a caveat: such policies, by design, only provide coverage for a limited period of time, leaving your heirs with no death benefit if you outlive the policy.

To be sure, term life insurance may be all the coverage your family needs, but if your income, financial priorities, or health status have since changed, you may have the option to convert it to a permanent life insurance policy.

One reason for a conversion to permanent coverage is that it may enable policyowners to accumulate cash value, which they can use during their lifetime to help meet their retirement and other long-term accumulation goals.

Permanent life insurance also provides a guaranteed a death benefit to your beneficiaries for as long as you maintain your policy, not just for a fixed period of time. Thus, permanent policies are often favored by those looking to enter their golden years with a way to pay for final expenses, provide additional financial security to a surviving spouse, or leave a financial legacy for children or grandchildren.

“You have to consider the individual’s financial need, but permanent life insurance can make a lot of sense as a long-term planning tool,” said Alex Panas, in an interview, a partner and wealth planner with Synthesis Wealth Planning in Morristown, New Jersey. “A lot of people buy term insurance early in their lives when they may not have the cash flow to pay for a permanent policy, but as their income improves or expenses go down it may make sense to convert the policy.”

That said, converting to a permanent policy, such as whole or universal life, typically costs more.

Jeremy Hallett, founder of online insurance marketplace Quotacy, said in an interview that premiums may be 10 times higher for whole life policies than they are for term life policies with the same death benefit because permanent insurance provides coverage for life with guaranteed level premiums. Actual premiums will depend on individual circumstances. (Learn more: Benefits of permanent life insurance)

Before consumers commit to a term-to-perm conversion, financial professionals suggest that they educate themselves on what they’re potentially gaining and what they may be giving up. (Related: The case for combining term and perm)

“It’s important to rely on guidance from a strong financial professional who can guide you through buying decisions so you don’t make an inappropriate choice,” said Marv Feldman in an interview, chief executive officer emeritus of LifeHappens, a nonprofit that seeks to educate consumers about insurance products and the insurance industry.

Here’s a look at the top five questions you should ask when contemplating a term-to-perm conversion:

1. Do all term life policies allow for conversions?

Many, but not all, term life insurance policies include a provision that allows policyowners to convert to a permanent policy at some point during the policy’s term. Most also offer the option to continue the term, but the premiums are generally much higher.

Typically, insurers charge a slightly higher premium for the option to convert, but some also offer a credit for a portion of the new policy premium in the first year. This may help offset the initial cost associated with conversion.

Convertible term life policies differ by product and insurer. Each has its own limitations and deadlines. For example, some allow policyowners to convert at any point before their term expires, while others allow conversions for only a specified period of time, say, the first 10 years.

Such policies may also impose age restrictions that only allow conversions until age 75. Longer conversion periods can significantly increase costs.

If choosing a term policy, consider both the conversion provisions and the policies available to convert to. (Learn more: Not all term insurance is the same)

Check your term life policy for deadlines and restrictions, or contact your financial professional for guidance.

2. Who might not be a candidate for conversion?

A term-to-perm conversion doesn’t always make sense, especially if you only want coverage during the years your family is most financially vulnerable, said Panas.

And in some instances it could be argued that someone may not need life insurance at all (term or permanent) if his or her resources (assets and savings) are sufficient that their household would not suffer a financial hardship if the primary wage earner died unexpectedly.

Of course, such circumstances are rare for the majority of people. And, logically, you don’t know if your resources are sufficient unless you know exactly what you and your family may face in the future.

It may also be best to stick with your term life coverage if you can’t afford the premiums associated with a permanent policy that provides the same level of death benefit coverage. While term life can offer more affordable premiums for the same coverage amounts, remember term life insurance will only pay a benefit if you die during the coverage duration.

Related:

4 times when term life insurance may be the answer

“I often come across people who may prefer the long-term security of a permanent life policy, but they need a bigger death benefit than they can afford,” Panas said, noting that term life coverage, which offers a bigger benefit for smaller premiums, is generally the better bet in that case. “It’s all about cash flow.”

As you weigh the pros and cons of conversion, don’t forget to consider your income stability. If you fear you might not be able to keep pace with the higher premium payments of a permanent life policy if your income suddenly dropped, it may be wise to keep your term life policy as is, which generally would keep your payments smaller. Remember, failure to pay your premiums on time means your policy would lapse and your family would not receive a death benefit.

3. Who might benefit from a term-to-perm conversion?

Permanent insurance is typically seen as a way to:

• Provide a basic amount of coverage to pay final expenses.
• Support a surviving spouse.
• Leave a tax-free legacy for surviving family members.

Because they are designed to accumulate cash value, they may also provide resources to handle sudden expenses during your lifetime, like costs associated with medical care, an emergency home repair, or college tuition. Of course, tapping cash values through borrowing or partial surrenders will reduce the policy’s cash value and death benefit. It also increases the likelihood that the policy will lapse, which could result in a tax liability.

Rebecca Murphy, an attorney and financial professional with Skylight Financial Group in Cleveland, Ohio, said that a term-to-perm conversion might make sense if you:

• Wish to leave an inheritance for your heirs, but want the freedom to spend what you saved for your own retirement. (Learn more: 6 ways life insurance can help with estate planning)
• Are divorced and want to ensure that a portion of your assets will be left to your biological kids via a death benefit when you die. (Learn more: Divorce and life insurance)
• Are a high-net-worth individual and wish to potentially minimize the size of your taxable estate by transferring your life insurance policy to a trust. Trusts are complex financial tools, however, that require the expertise of an attorney. (Learn more: 7 situations where a trust might help)

 

Indeed, life insurance offers a triple tax advantage. The cash value accumulates tax deferred, you can access the cash value tax free (up to the cost basis — the amount paid in policy premiums), and the death benefit from your policy is generally paid out to your heirs income tax-free. But, again, using the cash value also increases the chance that the policy may lapse and subsequently could result in a tax liability. (Learn more: Life insurance: 3 Income tax advantages)

You should also be aware that paying too much in policy premiums too quickly will trigger a federal rule regarding life insurance that may limit the tax advantage. Your life insurance policy will be declared a “modified endowment contract” (MEC) and the tax benefits that accompany cash-value life insurance policies may be crimped. You can learn more about MECs here.

4. Has my health status changed?

It could potentially also be wise to consider conversion if you experience a serious change in health status that might otherwise preclude you from purchasing a new policy, said Panas. That might include a diagnosis of heart disease, diabetes, or cancer.

Conversion privileges generally do not require policyowners to complete a medical exam, so they would not be denied coverage based on any change in life expectancy, provided they are making the change during the period their term policy allows for conversion.

“This is a time when it really makes a lot of sense to convert,” said Panas. “If someone gets a diagnosis of cancer, for example, or a terminal diagnosis, or for some reason believes that their life expectancy will be lower than they thought, they can potentially convert their policy and guarantee their family a death benefit payout.”

The conversion privileges in term policies don’t always last throughout the life of the policy, however. So, depending on the timing of a terminal diagnosis, this may not always be an option.

5. Can I do a partial conversion?

If you’d like to convert your entire term policy to permanent life insurance, but can’t afford the premiums, you may still be able to complete a partial conversion, if your insurer allows, in which only a portion of your original term life policy gets converted to permanent coverage.

Feldman says that he often counsels individuals to “ladder” into permanent coverage, converting 20 percent of their term life policy every two years as their earnings power grows.

“At the end of 10 years, they would have a fully permanent policy,” he said. “Sometimes, term life insurance is the only viable solution initially because of minimal cash flow, but if you have a convertible policy, you can potentially convert it into permanent life insurance over time.”

For many young families, term life insurance is their single biggest safety net, offering maximum financial protection at the lowest possible price. As their financial picture matures, however, those who seek a permanent solution for longer-term planning goals and those who experience a decline in health may wish to explore the pros and cons of a term-to-perm conversion.

“A term life policy with a conversion feature just gives you more options,” said Feldman.

Since 1851, MassMutual has been focused on helping people secure their financial future and protect the ones they love. That mission is why we have over 7,500 financial professionals to assist you on your journey through insurance, investing, retirement planning, estate management, and more. You can find a MassMutual professional with this tool or you can let us know you’d like to talk to one and we’ll have one of our financial professionals can contact you.

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Frequently Asked Questions

Q. Why would I want to convert my term life insurance policy?

A. Life changes, and so do your insurance needs. You might want to convert your term policy to permanent coverage if you've developed health conditions that make new policies expensive or hard to get. Conversion lets you lock in coverage without another medical exam, which can be a financial lifesaver if your health has declined. Plus, permanent policies build cash value over time—something term policies don't offer.

Q. When can I convert my term life insurance?

A. Most term policies include a conversion period, typically within the first 10-20 years of your policy. Your exact window depends on your specific contract, so check your policy documents or ask your insurance provider. Don't wait until the last minute—you'll want time to compare your options and make an informed decision.

Q. Do I need a medical exam to convert?

A. Here's the good news: no medical exam required. That's the whole point of conversion privileges. Your insurance company must allow you to convert based on your original underwriting, regardless of any health changes. This protection is especially valuable if you've been diagnosed with a serious condition since purchasing your term policy.

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9 questions you should ask about life insurance

Term vs. perm life insurance: 3 considerations

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This article was first published in March 2017. It has been updated.

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