When you're young and starting a family, a term life insurance policy can be a low-cost way to build a temporary financial safety net. The death benefit helps your family through a period when student debt, a mortgage and the costs of raising children may represent a crippling financial burden in the event of an unexpected death.
With a term policy, you get more coverage for every dollar you spend because you’re basically “renting” it; when that policy expires there is no payout and it loses all its value. For many young families, that's all the life insurance they need.
But as time passes, your financial picture can change: you may earn more money and build wealth, the kids will grow into adulthood and protecting their ability to go to college may morph into a desire to leave something for them. You’re not the same person you were when you purchased that term policy years ago.
As you get older, you may find the benefits of permanent life insurance — such as the ability to build stable cash value and leave a legacy — are more appealing. Rather than buying a completely new policy, people will often use a term conversion to move from term insurance to a permanent policy.
WHAT IS TERM CONVERSION?
Most term policies include a stipulation that lets you convert some or all of your coverage into a permanent policy within a specified time frame. While you could get a new policy, a term conversion can be easier. That’s because most companies allow you to convert without undergoing another health examination. Your premiums will still be affected by your age, but they won't be affected by any changes in your health. That means if you were healthy when you bought your term policy, the permanent insurance you convert to will be priced as though you're just as healthy, even if you're not.
WHY WOULD YOU CONVERT TERM TO PERM?
To build savings: When you convert all or part of a term policy into a permanent policy, you start building cash value (term doesn’t have this feature). As you pay your premiums, a portion of every payment goes toward the cash value which grows tax free and, with many policies, is guaranteed never to decline in value. Just like building home equity, someday down the road you could use that accumulated cash value for a number of purposes.
The earlier you start paying premiums into a permanent policy, the longer your cash value can grow tax free.
Now you can afford it: You may have purchased a term policy when you were younger and needed a lot of coverage but couldn’t afford higher premiums for permanent life insurance. Now, perhaps your salary has grown, and you can afford a life insurance policy that is flexible and will grow with you over time.
For estate planning: If you’ve accumulated a significant amount of money and property, your heirs could be on the hook for a significant estate tax bill after your death. With a permanent life insurance policy, your heirs could use the death benefit to pay those taxes or use it as a source of ongoing income. Most of the time, proceeds from a life insurance payout aren’t considered taxable income.
WHAT ELSE SHOULD YOU KNOW?
Conversion Credits: Sometimes insurance companies will offer conversion credits to offset the costs of increased premiums on a permanent life insurance policy. The conversion credit may result in lowered premiums for the first year. If you’re looking into a term-to-perm conversion, be sure to inquire about a credit.
Convert in stages: You don’t have to convert your term policy in its entirety; instead, you can do it in small chunks when circumstances warrant. That way, you can enjoy the benefits of both policies and gradually step into a permanent policy as your budget allows.
Ask about your options: Some companies will limit the kinds of permanent policies you can convert a term policy into. If you are looking into purchasing a term policy, be sure to ask about your conversion options to ensure you aren’t locked into a policy that’s more expensive than you want.
Research the company: Insurance companies vary in their financial stability. You’ll want to purchase policies from companies that have the strongest credit ratings from third-party companies like Moody’s or Fitch.