Is Converting Term Life to Whole Life a Smart Financial Move?

I think about my term life insurance policy like baking with my 5-year-old: The results are for her, not for me (which explains how we ended up making potato-chip-and-sprinkles cookies). The security of knowing my family is covered is what matters. 

Still, I can’t deny there’s an appeal to a guaranteed result. One option might be to look at a convertible life insurance policy, which starts out as term life but offers the option to convert to a permanent life insurance policy later. 

I wanted to learn if converting term life to whole life was a recipe to protect my family’s future, or if I’d end up with more on my plate than I wanted. Here’s what I found out.

What Is Convertible Life Insurance?

Life insurance policies fall into two broad categories, term or whole life insurance. Term life insurance provides coverage for a specific length of time (like 10, 15 or 20 years). If the insured person dies during that time, their beneficiary gets the death benefit. When the term expires, the policy simply ends. There’s no more coverage and there’s no there’s no cash value to collect. 

On the other hand, a permanent life insurance policy, such as whole life insurance, does not have an expiration date. It accrues a cash value component that the insured person can borrow from or withdraw during their lifetime. Permanent life insurance policies are much more expensive than term life.

A convertible life insurance policy is a term life insurance policy that you can change to a permanent policy later on. 

“For a young person, newly married with children and with a limited budget, purchasing the most coverage at the lowest cost makes the most sense,” says Clifford Caplan, a Certified Financial Planner (CFP). In that case, term life insurance may make the most sense.

But even if that’s the case, you might opt for term life that you can convert later, especially if you’re interested in permanent life insurance down the road. (The term life insurance policy sold through Fabric is not convertible to whole life insurance.)

Top Reasons to Convert Term Life to Permanent Insurance

The big question is: Will converting to a permanent policy be the right move, or will it mean more coverage (and costs) than you need?

“The biggest reason we see clients converting is that they decide they want the coverage to continue through retirement,” says Zachary Bachner, CFP. “Some have mortgages, college costs or other needs throughout retirement that may be covered by life insurance if they were to pass away. It is also an efficient way to leave an inheritance if other assets are not available.”

If this applies to you, you might want to convert your policy or make another plan to continue life insurance coverage.

Debt

An important reason to have life insurance coverage is to protect your loved ones from financial hardship when you pass away. If you’ll still have considerable debt when your term policy expires, you may want to consider keeping a life insurance policy.

Permanent dependent

Many parents of young kids expect that in 20 years or so, their children will be living independently. If you don’t need to support your children, you may have much less need for life insurance coverage (although there are reasons why child-free people can still benefit from life insurance). 

Parents of children with special needs or people with other lifelong dependents may want permanent life insurance to help provide that continued care.

Estate planning

If the value of your estate exceeds certain limits, your loved ones will have to pay estate tax out of what you leave behind, which lowers their inheritance. Federal estate taxes don’t kick in until your estate is worth more than $11.7 million, so most families won’t have to pay these taxes. Twelve states and the District of Columbia also have estate taxes that apply much earlier—$1 million to $5.9 million, depending on the state.

If you anticipate that your estate will be subject to estate tax, then a permanent life insurance policy can provide funds for your beneficiaries to use to pay those taxes. And the life insurance benefit is generally not taxable.

Cons of Converting Term Life to Whole Life Insurance

Although converting term life to whole life can make sense in some situations, it’s not a one-size-fits-all solution. Lots of families naturally outgrow a need for life insurance as children grow up and form their own households. Some people view the cash value element of a permanent policy as part of their wealth management strategy, but others find more effective ways to grow their savings. Consider potential drawbacks and alternative options before going for term life conversion as a default choice.

High cost

Whole life insurance can easily be 10 times as expensive as a term life policy with the same amount of coverage. The older you are when you convert the policy, the higher your premium rates will be. A policy might not be as attractive if the new premiums would chip into money you’d like to put toward other savings or activities. 

Unnecessary coverage

When you have people counting on you to support them financially, it’s essential to protect them. Life insurance is an important form of financial security for people supporting kids, partners or other loved ones.

When the kids are grown and flown, the house is paid off and you’ve got plenty of savings, it can be harder to justify expensive premium payments on a whole life policy. It may be easier for you to self-insure than it was in your 20s. Review your finances with a qualified advisor to assess whether your coverage is just right or if you’re paying for more than you need. 

Lower returns

Whole life insurance comes with a guaranteed rate of return on the cash value portion of your policy. As long as you keep making payments, you’re going to accrue value (as opposed to stock market investments, where you can lose as well as gain). But many providers choose fairly conservative forms of investment for your cash value, so gains can be modest, and inflation cuts into that value. 

Consider what you’d want loved ones to be able to pay for with a whole life insurance payout. You might realize that there are other financial options that make more sense for you.

When Should I Convert My Policy?

Some policies only let you convert from term to whole during a specific term conversion period, or before you reach a certain age. Others may allow you to convert the policy at any point. Policies may require you to convert your entire coverage amount, or they may allow you to convert a portion and leave the rest under the original term life policy. Check your policy for details about your options.

“If it becomes apparent early on that you will need to maintain coverage beyond the guaranteed period, you should consider converting earlier than near the end of the term,” Caplan says. Your whole life policy rates will be based on your age when you convert, so if you know you’ll want the coverage, converting early can lock in lower rates.

Converting the policy is a matter of completing and submitting conversion paperwork. You don’t need to take another medical exam. The permanent policy premiums are based on the rating you received when you applied for the initial policy (how do life insurance companies assess your risk?), even if you’ve developed health issues since then. Your age will affect your new permanent policy rates, though, meaning that the older you are when you convert, the higher the premiums will be. 

If you convert at 35, you’ll lock in rates for a 35-year-old based on the health rating you got when you purchased the policy. Waiting until 45 means a bigger premium jump.

Alternatives to Converting Life Insurance

“The magic of life insurance is that it provides benefits when they generally are needed most. If someone opts not to purchase life insurance, the next best option is to establish a fund that provides the necessary money to meet your obligations,” says Caplan. 

Explore these ideas for saving, investing and finding new insurance. You might decide that one or a combination of several options works best to minimize costs and offer greater potential gains.

New term life policy

If you’re in good health, it’s worth investigating whether a new term policy could offer you continued coverage at a lower rate than converting a current policy. A non-smoking 40-something in excellent health may decide they still want insurance to cover them after the policy they bought in their 20s expires. Term life may still be a cheaper way to get the coverage they need.

Final expense insurance

Whole life insurance policies tailored to seniors are often designed to cover funeral service and burial costs, although your beneficiary has freedom to use the funds for whatever they choose. These policies typically cap coverage around $5,000 to $25,000, which is enough to cover the average person's funeral expenses. Often, no health exam is required, and your coverage is guaranteed as long as you're a U.S. citizen residing in the U.S. or permanent legal resident. (Here's more info on life insurance for seniors.)

Annuity

An annuity is an insurance product that can help some people save for retirement. You pay into the annuity fund and money grows tax-deferred. You can arrange the annuity so you receive regular payments later for a defined period or for the rest of your lifetime. Annuities can come with high commissions and fees, but one advantage is they don’t have contribution limits that some other retirement savings accounts do.

Other investments

Bachner points out that once a life insurance policy expires, you may have more cash on hand to save or invest elsewhere. 

Average gains in the stock market tend to be notably higher than the guaranteed gains of a whole life insurance policy. Everyone has their own comfort level with more conservative or risky investments. 

Permanent life insurance policies tend to concentrate on conservative subaccounts to grow your cash value. If you’re interested in following a bolder approach, you might choose a more aggressive investment strategy for yourself (or an advisor who can help you create one). You could also open an additional retirement fund or pursue other savings strategies.

Finding the balance between affordable coverage and long-term savings is an important consideration for lots of families. Term life and whole life insurance each carry their own advantages, and in some cases it might make sense to graduate from one to the other through a convertible policy. 

That said, many people may find a better fit by tailoring their savings and insurance plans to fit their family goals and lifestyle. The important thing is keeping your family covered so you can enjoy a worry-free return to the (messy, sticky, flour-dusted, sweet) activities you love together.

Fabric exists to help young families master their money. Our articles abide by strict editorial standards. This article has been reviewed and approved by a compliance professional who is a licensed life insurance agent.

Information provided is general and educational in nature, is not financial advice, and all products or services discussed may not be offered by Fabric by Gerber Life  (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Consult an attorney or tax advisor regarding your specific legal or tax situation. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. The views and opinions of third-party content providers are solely those of the author and not Fabric by Gerber Life.