Should You Convert Your Term Life Insurance Policy?

A term life insurance policy provides coverage for a specific period, such as 10, 20, or 30 years. Many of these policies include a feature known as a conversion privilege, which allows the policyholder to change their temporary term policy into a permanent life insurance policy. This conversion can occur without the need for a new medical examination or additional underwriting, even if the policyholder’s health has changed since the original policy was issued.

Understanding the Conversion Feature

The conversion privilege is a contractual right embedded in many term life insurance policies. It enables a policyholder to switch from their current temporary coverage to a permanent life insurance policy, such as whole life or universal life, offered by the same insurer. This feature often bypasses the typical underwriting process, including medical exams, which is beneficial if the policyholder’s health has declined.

Term life insurance provides coverage for a set duration, offering a death benefit if the insured passes away within that timeframe, but it does not accumulate cash value. In contrast, permanent life insurance offers coverage for the insured’s entire life, as long as premiums are paid, and includes a cash value component that grows over time. This cash value can be a source of funds for the policyholder during their lifetime. The conversion feature bridges these two types of coverage, allowing a transition without interruption.

Evaluating the Decision to Convert

Deciding whether to convert a term life policy involves assessing personal financial goals and evolving insurance needs. One primary reason for conversion is the desire for lifelong coverage, which can be important for estate planning, covering final expenses, or leaving a legacy for beneficiaries. Permanent policies offer a guaranteed death benefit for the insured’s lifetime, providing a sense of financial security that term policies, with their expiration dates, do not.

The accumulation of cash value within a permanent policy is another common motivation for conversion. This cash value can be accessed later in life for various purposes, such as supplemental income or unexpected expenses. Conversely, conversion may not be suitable if the policyholder’s financial needs no longer require lifelong coverage or if the significantly higher premiums of permanent insurance are not affordable. A significant factor in the decision is the “conversion period,” which is the specific timeframe during which the conversion option is available. This period can vary by insurer and policy, often being limited to a certain age, such as 65 or 70, or a specific number of years from the policy’s issue date. It is prudent to check the policy documents or contact the insurer to understand these deadlines, as the conversion option can expire before the term policy itself.

Steps to Convert Your Policy

The process of converting a term life insurance policy begins with contacting the insurance company or a financial professional. They can provide specific details about the policy’s conversion options and the types of permanent policies available for conversion. It is advisable to have your policy number readily available when making this inquiry.

The insurer will then provide the necessary conversion forms and illustrations for the various permanent policy options, such as whole life or universal life. Carefully review these documents to understand the features, benefits, and costs associated with each permanent policy type. Once a decision is made, complete the required paperwork accurately. After completing the forms, submit them to the insurance company along with the first premium payment for the new permanent policy.

Financial Aspects of Conversion

Converting a term life policy to a permanent one involves a notable change in financial commitment. The premiums for the new permanent policy will be considerably higher than those for the original term policy. This increase reflects the lifelong coverage provided by permanent insurance, as well as the cash value component that begins to accumulate.

New premiums are calculated based on the policyholder’s age at the time of conversion, rather than their age when the original term policy was issued. Some insurers may offer a conversion credit, which could reduce the initial cost of the new policy. A portion of each premium payment contributes to this cash value, which grows on a tax-deferred basis. This means taxes are not due on the growth until the funds are accessed. Policyholders can access this cash value through loans or withdrawals, providing a potential source of funds. However, accessing cash value can reduce the policy’s death benefit and, if withdrawals exceed the amount of premiums paid (the “cost basis”), the gains may become taxable as ordinary income. Loans against the cash value are tax-free as long as the policy remains in force and the loan is repaid.