When it comes time to buy life insurance, the first decision to make is term versus permanent life insurance. You’ve probably heard that term life insurance is more affordable than a permanent policy, even if you aren’t quite sure what the difference is.
Before you buy any product, but especially life insurance, you should spend a good chunk of time learning about it through unbiased sources of information. But if you choose term life insurance, even after you make that decision, you aren’t finished learning.
Because odds are high, you’ll have another chance to make that choice. Many term life insurance policies come with a provision that makes them “convertible” into permanent policies, like whole life or universal life.
Here’s what you need to know:
How a convertible life insurance policy works
A convertible life insurance policy is simply a term life insurance policy that can convert to a permanent life insurance policy. Here’s how it works: Let’s say a 35-year-old man buys a 30-year convertible term life insurance policy. At age 45, he decides to convert that policy to a permanent life insurance policy. He will pay a substantially larger premium as a result but have coverage for the rest of his life.
Most convertible policies have a time limit to convert, usually 10 years. Often, when the conversion option is close to expiring, life insurance companies let policyholders know that time is running out to execute this option.
Who should consider a convertible life insurance policy
Why would our 45-year-old take his insurance company up on that offer? Converting from term to permanent has one big advantage: Generally, the policyholder doesn’t have to prove “insurability” to do so. That is, he won’t have to take a medical exam to qualify for coverage. For someone who’s gone through a big health change, this can be a major benefit. It’s possible this man might be ineligible to buy a brand-new whole life policy at 45 – or at 65 when his policy’s term ends, so the term conversion would be his only option or at least a much more affordable option.
Term conversions aren’t for everyone. In fact, the circumstances under which a conversion makes sense are fairly limited, and market data shows policyholders seem to understand this because few convertible term life insurance policies are converted.
In most years, fewer than 1 percent of policies studied were converted, according to a study by the Society of Actuaries. However, in year 10 the number of conversions jumped. Why year 10? Because the options to convert the policies were expiring.
While the conversion itself is free, premiums jump considerably – at whatever the market rate for permanent life insurance policies might be, which can be 6 to 10 times that of the term life insurance premiums.
There are specific circumstances where converting from term life insurance to a permanent life insurance policy can make sense:
- A family with a child that needs permanent care into adulthood can benefit from the creation of a large nest egg that survives the parents. (Remember, with term life insurance, there is no benefit after the term runs out.)
- Someone with dramatic health issues might also benefit from the option to obtain a policy without a medical exam.
- Finally, a family that has enjoyed financial success and is looking for a tax-advantaged way to leave money to heirs whenever the insured person dies can benefit from using a universal or whole life policy to transfer that money to children or other beneficiaries.
What to know when buying convertible term life insurance
Here are the top things to consider when buying convertible term life insurance:
Premium cost
Convertible term life insurance policies tend to cost more than non-convertible term life insurance policies. When you convert, your premiums will rise, so make sure it’s worth it. Some insurers will ease the blow by offering “term conversion credits,” which can lower the premiums at first, but this “discount” usually only lasts a short time. Another available option to keep costs down is to do a partial conversion, which would split the death benefit between the existing term life insurance policy and the new, converted permanent policy.
Term length
Make sure you understand your policy’s conversion terms. Deadlines can vary a lot. Some policies must be converted before the policyholder reaches a specific age, such as 75, or even 65. Some can only be converted in the first 10 or 15 years of the policy. Usually the older and longer the term, the better.
Conversion options
Some policies can be restrictive about what kind of permanent policy is available to the policyholder, while others are more open. Ideally, your convertible term life insurance allows you to convert to any permanent policy. Usually, the more options you have at conversion, the better.
Fees and commissions
Make sure you understand who’s getting paid and how much. Policyholders should understand where their money is going and why a company might encourage the purchase of one product over another.
Bob Sullivan is a veteran journalist and the author of five books, including the 2008 New York Times Best-Seller, “Gotcha Capitalism,” and the 2010 New York Times Best Seller, “Stop Getting Ripped Off!” He specializes in computer crime and consumer fraud stories. He has won the Society of Professional Journalists Public Service Award, a Peabody award, and the Consumer Federation of America Betty Furness Consumer Media Service Award. He’s now a syndicated columnist and frequent TV guest. He is also the co-host of the podcast Breach, which examines history’s biggest hacking stories. Opinions are his own.
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