At Insurance and Estates, we don’t believe there is a one-size-fits-all product out there that can be considered the best life insurance. In fact, we often will recommend different products based on each client’s specific needs, goals and objectives.
The following article covers convertible term life insurance: what is it, who needs it and why you would want to convert your term policy to either whole life or universal life.
What is Term Life Insurance?
There are two primary types of life insurance: term and permanent.
Term life insurance is defined as a contract between the owner of the policy and the insurer, for a policy on the life of the insured, whereupon the insured’s death, the insurer pays a lump sum death benefit to the beneficiary.
The policy is for a set period of time, typically ranging from annual renewable term (1 year), 5 years, 10, 15, 20, 25 and 30 year term periods.
Once the term expires, the coverage ends. The owner has the option to keep the policy at higher premiums, or in some cases, at a lower face amount.
Alternatively, the owner may choose to exercise a conversion option if the policy is convertible term life insurance.
What is convertible term life insurance?
Convertible term life insurance definition: most term policies include an option to convert. If you choose to exercise this option, it allows you to convert all or a portion of the existing death benefit to permanent insurance coverage, such as whole life or universal life, with no evidence of insurability required (i.e. no medical exam or health questions). The option to convert must be exercised prior to the end of the term or by a certain age, typically 70 or 75.
How is my new premium determined?
When you convert your term to permanent coverage, the carrier uses your initial health class and your current age to determine your new premium for the permanent coverage.
Since your initial health class determines you conversion health class, you do not have to answer any questions regarding your health and lifestyle and you do not have to take a life insurance blood test or provide a urine sample.
What are the advantages of convertible term life insurance?
We wrote an entire article on the term life vs whole life insurance discussion. Although there are various convertible term insurance pros and cons (discussed below), the primary benefit is it provides you with a “worst case” scenario option.
In other words, if you have a term policy and you get sick or injured in a way that would prevent you from being insurable, you can convert to a permanent life insurance policy without taking a medical exam or answering health questions and keep the life insurance coverage the rest of your life.
In addition, the following convertible term life insurance pros should be considered:
Price. There are many term life insurance pros but probably the most obvious is the initial low entry premium payments. Term life is “pure” death insurance, meaning there is no cash value accumulation. The main purpose of the policy is to pay a death benefit to the beneficiary named in the policy.
Income Tax Free. The next major advantage of term life insurance is the death benefit goes to the beneficiary income tax free. There are exceptions, such as when the policy names the estate of the deceased as the beneficiary, but the majority of the time life insurance is not taxed.
Flexible. Another advantage of term life is that the terms are flexible. You can choose coverage different term periods, such as annual renewable term, 5, 10, 15, 20, 25 and 30 years. And when the term of the policy ends, the policy is normally renewable on an annual basis.
Note, however, that a downside to renewable term life insurance is that the you are saddled with higher premiums when you renew the term annually, or the face amounts drops, or both.
Protects Insurability. The primary benefit of a conversion option attached to term life is that the insured can convert the policy without proof of insurability. Which means that you made the decision to get your life insured, that way, if you develop some type of health condition that would either make it impossible or cost prohibitive to purchase another policy, you can always convert your term policy to permanent coverage, regardless of your health condition.
For example, suppose you take out a 20 year term upon getting married. You have 2 kids by age 40. Unfortunately, at age 42 you develop a rare disease that will either cause you to be declined for additional coverage or will make your premiums cost prohibitive. The good news is you have convertible term life insurance, which allows you to exercise the option with the insurance company to keep your coverage for the rest of your life by converting the term policy to whole life or universal life.
At I&E, we are huge advocates of cash value life insurance. We believe there are many whole life insurance pros that need to be considered when pitting permanent coverage against temporary term life. In addition, the life insurance company you choose is also of great importance.
Having said that, permanent policies are not for everyone. Some people simply cannot afford the premium. In that case, convertible term life should be considered.
Term life insurance with a conversion option should be considered by the following:
Although we are not fans of the mantra buy term and invest the difference, we do believe that a convertible term life insurance policy is appropriate in many situations and for many types of people.
Young Parents. If you are just starting out a family you may want to consider term life insurance with a conversion option if you are on a thin budget and your primary concern is income replacement.
Alternatively, consider setting up a cash value life insurance policy with a term rider to get the needed death benefit coverage but with the benefits of cash value life insurance.
New Business Owners. One of the main issues new business owners run into is cash flow. One way to keep initial costs low would be to choose convertible term life insurance initially. Then once the cash flow increases and the margins get a little more manageable, you can convert to permanent life insurance, which is far superior when structuring buy sell agreements.
Small Business/SBA Loans. Many small business loans and SBA loans require that the person taking out the loan have some sort of life insurance in place. The proceeds from the death benefit are collaterally assigned to the bank, with the remainder going to a named beneficiary. Rather than pay the larger price tag that goes along with permanent coverage, simply getting a term policy for the length of the SBA loan should suffice. If you decide you prefer to keep the coverage, you can always exercise the conversion option and keep the coverage.
Why Convert Your Term Life Insurance
Without recapping our many articles highlighting the amazing benefits of cash value life insurance, we will provide 6 benefits to converting your term policy.
Cash Value. One huge benefit of a solid permanent life policy is the tax deferred cash value accumulation. Further, the cash can be used as collateral for a life insurance loan, either through the carrier or from a bank.
And another great benefit is the cash value grows in a tax favored environment, with the final death benefit from your life insurance going to your beneficiary income tax free.
Estate Planning. Permanent coverage is important when you are looking to protect your estate through various strategies, including setting up an irrevocable trust. If your estate is subject to a state death tax, or it exceeds the 2018 federal estate tax limit of $11,200,000, having permanent coverage to help pay the tax bill is essential for passing your estate on to your heirs.
Business Planning. For the savvy older business owner, having a business succession plan in place is priority #1. Using life insurance to fund a buy sell agreement provides the needed liquidity to make sure the business can survive the loss of an owner.
Legacy Creation. Many of the high net worth clients we have worked with over the years who desire to leave a legacy use life insurance for wealth building. As mentioned above, the tax incentives provided under IRC 7702 uniquely position cash value life insurance as one of the greatest assets to own.
Life Settlement. If you still don’t see an advantage to converting your term policy, then consider a viatical settlement. Life insurance statistics show that 98% of term life expires worthless. If you are nearing the end of your term, consider converting your policy and selling it.
Bonus benefit. Another option if you don’t need the life insurance is to have your family pay for the premium once you have converted the term policy. It might make a great investment for your children if they help pay some or all of your premiums in order to get a death benefit one day.
The Best Convertible Term Life Insurance Companies
Last, but certainly not least, make sure you get your convertible term life insurance with the right company. Many carriers that offer a conversion option have rather weak permanent coverage options to choose from.
Instead, choose a company that you know has a solid dividend paying cash value life insurance policy that you would want to convert your term policy into.
Also, make sure that your contract allows you to convert to the permanent policy of your choosing and doesn’t limit you to a pre-defined substandard policy option.
Companies such as MassMutual, Ohio National, Penn Mutual, Minnesota Life and American United Life all offer convertible term life insurance with the option to convert to excellent cash value policies.
The alternative is to select the lowest priced term life policy that will only offer you guaranteed universal life insurance with little to no cash value. Granted, you saved money with by choosing the cheapest policy available. However, the small amount of money you saved is not worth the under performing permanent coverage you are stuck with, unless your only need for the insurance coverage is the death benefit.
Renewable Does Not Mean Convertible
It should be pointed out that some companies offer renewable term life insurance. Renewable term life insurance is offered in two different flavors.
First, there is annual renewable term life insurance, where the policy renews each year at an increased premium. This policy works great for someone who needs coverage for a 1-3 year time frame. After the initial 1-3 years the policy’s premium is typically similar to a 10 year term policy. So rather than choosing a yearly renewable term life insurance policy, choose a 10 year term for the same price over the length of time you need the coverage.
Second, renewable term life insurance also refers to the ability to keep the term life policy once the initial term has expired. Many carriers offer a guaranteed renewable option up to age 90 or 95. However, the premiums go up substantially each year or the death benefit decreases substantially each year. Therefore, if you plan on keeping the coverage beyond your term, utilizing your conversion option is the best choice.
Convertible term life insurance can be a valuable tool in anyone’s wealth building tool box. The advantages of term life, coupled with the ability to convert to permanent coverage, provides you with peace of mind all around.
If you are interested in a convertible term life insurance quote from one of the top cash value life insurance companies, please give us a call today.