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

A term life policy can be a little bit like taking a walk with a 3-year-old: The journey is more important than the destination (stopping to examine each pinecone along the way is half the fun!). Knowing that life insurance can help cover my family matters helps provide me with peace of mind.

Still, I can’t deny there’s an appeal to making sure my loved ones get to claim a death benefit, even if I outlive my planned term coverage. One option might be 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 could 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 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. Note that loans from cash value will accrue interest; loans and withdrawals may generate an income tax liability, reduce the account value and the death benefit, and may cause the policy to lapse.

Due to both the lifetime coverage (as long as the premiums are paid) and the cash value component, 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. The rates are typically much lower than getting a whole life policy right off the bat, and you can keep the option open to make the switch to permanent coverage if you decide that’s right for you. (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?

In many cases, people use life insurance as a way to help provide financial support for their loved ones. If your family relies on your income, you’d want a backup plan to provide for them even if you’re gone. But as career years wind down, some families are ready to rely on their savings or other resources and feel comfortable letting coverage go.

But many other people may still have mortgages or other debts, college costs or other important expenses in their retirement years. If you don’t expect to be ready to “self-insure” with your own assets, 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 help 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 estate will have to pay estate taxes, lowering the inheritance that’s left for your loved ones. Federal estate taxes don’t kick in until your estate is worth more than $13.99 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, 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 life insurance proceeds are generally not subject to federal income tax, though they may be included in the taxable estate if the insured owned the policy.

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. Not all term policies even offer the option to convert to whole. Lots of families naturally outgrow a need for life insurance as children grow up and form their own households. Consider the potential drawbacks and alternative options before going for term life conversion as a default choice.

High cost

Whole life insurance can be more 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 help protect them. Life insurance is an important way to help provide 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. 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. 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.

Your whole life policy rates will typically 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, 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

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.

Small whole life policy to cover final expenses

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 typically enough to cover the average person's funeral expenses. Often, no health exam is required.

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

Once a life insurance policy expires, you may have more cash on hand to save or invest elsewhere. Everyone has their own comfort level with more conservative or risky investments.

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 the 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.