How a term-to-permanent life insurance contract conversion works

The bottom line:

The main difference between term & permanent life insurance is how long your financial protection lasts.

Convertible term insurance allows you to change your death benefit to permanent.

Not all term life insurance is convertible; check to see if yours is.

• What is a term-to-permanent life insurance conversion?
• Should you convert your term life insurance to a permanent life policy?
• What happens to term life insurance at the end of the term?
• When can you convert term to whole life or other permanent coverage?
• How do you convert from term to permanent life insurance?
• What type of permanent life insurance should you choose?
  
  • Considerations of converting term to whole life insurance.
  • Considerations of converting term to universal life insurance.
  • Considerations of converting term to variable universal life insurance.
• How much does it cost to convert a term policy to a permanent policy?
• Should you convert all of your term insurance to whole life or permanent life insurance?

A term-to-permanent life insurance conversion, or “term-to-perm” conversion, allows you to extend your life insurance coverage. You may have a 10-,15-, 20- or 30-year term life insurance contract now. Instead of letting it expire, you may be able to exchange it for a permanent policy without needing a new medical exam. After switching to the permanent policy, you’ll have a death benefit that lasts your entire life (as long as premiums are paid and the contract retains value). The new policy’s premium payments will likely be higher.

Learn about the main differences between term and permanent life insurance by reading "Term vs. whole life insurance: Everything you need to know." (Whole life is the most common type of permanent life insurance. So it’s a good place to start.)

Think about converting term life insurance to permanent life insurance if your financial goals or strategy have changed. Here are a few reasons to consider converting your term life policy:

As a term policy approaches the end of its coverage period (or the end of the time when you’re expected to make payments), you may want to extend the protection that permanent life insurance provides.

If your health has worsened and you need coverage for a longer period of time, a conversion may be your best (or only) option. You likely won’t have to redo your medical exam. In most cases, your new policy will be priced in the same risk class that your term contract was. However, you’ll need to be within your policy’s conversion window. (If your health has improved since you first applied for term coverage, it may be more cost-effective to open a new policy than to convert.)

Maybe you originally wanted permanent life insurance, but the higher cost kept you from purchasing it. If you now have the means to upgrade to a longer-lasting policy, a conversion may be the answer. People with a high net worth, who have a complex financial strategy, sometimes find permanent life insurance useful.

Maybe you now have responsibility for someone who will always be financially dependent on you (for example, a child with special needs). Or perhaps a loan or mortgage payment period was extended. It’s also possible you need to update plans for inter-generational wealth transfer. Permanent life insurance may help meet the needs.

Sometimes, life insurance is used as part of business continuity planning (planning to protect business assets and personnel if disaster strikes). If unexpected business obligations arise, a conversion may be one path to permanent life insurance.

As you grow older, your financial goals may simply shift. A life insurance policy that stays with you for a lifetime may be part of an updated financial approach.

Not sure how much life insurance you need after a change? Use this life insurance calculator to find out.

Term life insurance is built to last until the end of the time period you selected (usually 10 to 30 years). After that, you may see steep price increases to continue coverage (which would happen after your premium payment period has ended). If you’re still alive when your term life insurance policy expires, there is no financial payout or cash value. On the expiration date, you’ll be faced with four choices:

1. Go without life insurance. You decide that your financial obligations no longer require it.

2. Renew your term life insurance. Perhaps your family or dependents have changed and you need life insurance for more years than initially expected. Some insurers offer a year-long extension to your existing coverage. You may be able to renew each year for an increased premium.

3. Open a new term or permanent life insurance policy. Sometimes it makes sense to buy additional protection or buy a different type of policy.

4. Convert your term policy. If you plan ahead, you may have a fourth choice as well: Convert your term life insurance into a permanent life policy.

You may be able to convert term to permanent coverage within the limits set by your insurer. You’ll first need to check if you have convertible term life insurance. Read your policy documents or ask your financial advisor if your term life policy can be converted.

Then, check when the conversion is available. Some insurers allow you to convert throughout the duration of the contract. However, it’s more common to only have a conversion option during the first years your life insurance is active. For example, a 15-year life insurance policy may allow conversions for the first five years a policy is open. A 30-year policy may only allow conversions for the first 10 years.

Some insurers also have a maximum age requirement. You may not be able to convert if you are more than 65 years old, for example.

Convert from term to perm life insurance by following these four steps:

1. Find your conversion deadline. Plan ahead. If you know a term-to-perm conversion is something you may want to pursue in the future, pay attention to the dates allowed in your contract. Buy a convertible term life insurance policy from the start. If you don’t know the conversion deadline, read your contract documents or ask your financial advisor.

2. Choose the type of permanent life insurance you want. Three types of permanent life insurance that are commonly available are whole, universal and variable universal.

3. Calculate the new policy cost. There is usually no direct cost to convert term life insurance to a permanent policy. However, premium payments will likely be higher. Consider a lower coverage amount on the new policy if you’re interested in keeping premium amounts lower.

4. Convert. Decide whether to do a partial or total conversion of your existing policy. Usually, a financial advisor will step in to help with paperwork. You can expect to review and sign a new contract.

Choose a type of permanent life insurance that aligns with your financial goals and strategy. During a term-to-permanent conversion, your permanent life insurance choices will vary based on your insurer. Choices may include whole, universal or variable universal life insurance. There are pros and cons to each of these.

If you’re converting from a term to a whole life insurance policy, you’ll notice higher premiums and the cash value of the new policy right away. Whole life insurance is the most common type of permanent life insurance, according to the Life Insurance Information Institute. A few pros and cons of converting term to whole life insurance are noted below.

• Longer-lasting coverage to help you transfer wealth.  Your loved ones will receive a death benefit (a financial payout) when you die, no matter when that occurs. There’s no 10- or 15-year expiration date like you might see with term life insurance. You must keep paying your premiums in full to continue coverage.

• Consistent premiums. Premium payments are consistent for the duration of your insurance coverage, just like with many term life policies. Limited payment options may also be available with some whole-life contracts.

• Cash value. Whole life insurance has cash value growth.¹

• Estate planning. Possibilities to support your estate plan may be more accessible with whole life insurance than with term coverage.

• Typically higher cost than term life insurance. Whole life insurance premiums may cost more than five times what a term policy costs.

• Premium payments might not have an end date. Some life insurance policies expect payments for as long as coverage lasts. This could make it difficult to keep paying if your income frequently changes or you lose your job. Before you buy, make sure the premium payments are affordable for the long term.

• Cash value isn’t as easy to access as your checking account.  You might pay fees or taxes when you access the cash value of a whole life policy.² Removing money will also lower the value of your death benefit. Removing too much money can terminate your coverage entirely. It can also make it take longer to meet your life insurance contract goals. Always talk with a financial advisor before altering planned contributions.

• Lower cash value growth rate. Whole life insurance may have a lower growth rate than other investment strategies you might pursue.

Universal life insurance is similar to whole life insurance. Again, you’ll notice the higher premiums and cash value of the policy upfront. But universal life insurance usually offers more payment flexibility than whole life insurance does. A few of the pros and cons of converting term to universal life insurance are noted below:

• Longer-lasting coverage to help you transfer wealth. Your loved ones will receive a death benefit (a financial payout) when you die. There’s no 10- or 15-year expiration date like you might see with term life insurance. You must keep paying your premiums in full to continue coverage.

• Cash value earns interest. Universal life insurance has cash value. And many insurers offer consistent growth on the cash value of your policy. You could expect to see an annual interest rate at which your money will grow.

• Gain premium payment flexibility. Adjust how much to pay into your policy—and when—within the limits set by your insurer.

• Estate planning possibilities. Possibilities to support your estate plan may be more accessible with universal life insurance than with term coverage.

• Higher cost than term life insurance. Universal life policies typically cost more in exchange for cash value and premium payment flexibility.

• Cash value isn’t as easy to access as your checking account. You might pay fees or taxes when you access the cash value of a universal life policy. Removing money will also lower the value of your death benefit. Removing too much money can terminate your coverage entirely. It can also make it take longer to meet your life insurance contract goals. Always talk with a financial advisor before altering planned contributions.

• Flexible payments have limitations. You’ll want to be mindful about speeding up or slowing down contributions to your life insurance. When you reduce premium payments, this affects the future cash value of your life insurance. It can also decrease the death benefit available to your beneficiaries. Reducing premium payments can make it take longer to meet your life insurance policy goals. Always talk with a financial advisor before altering planned contributions. Also, note that adding a large lump sum to your life insurance policy can result in the IRS reclassifying it as a modified endowment contract. These contracts have different tax-time rules than standard life insurance.

• Lower cash value growth rate. Universal life insurance may have a lower growth rate than other investment strategies you might pursue.

Variable universal life insurance³ is similar to both whole life insurance and universal life insurance. What sets this type of policy apart is that its cash value has options for subaccount investments, with the potential for greater gains or losses. Read the pros and cons of converting term to variable universal life insurance below.

• Longer-lasting coverage to help you transfer wealth. Your loved ones will receive a death benefit (a financial payout) when you die. There’s no 10- or 15-year expiration date like you might see with term life insurance. You have to keep paying your premiums in full—and your policy must retain value—to keep the death benefit active.

• Cash value with potential for greater gains or losses. The cash value of your life insurance can be placed in variable and fixed subaccounts.

• Investment options give you choices for potential long-term growth. The cash value inside a policy can grow or decline after you place it in a market-based investment option.

• Gain premium payment flexibility. Adjust how much to pay into your policy and when within the limits set by your insurer.

• Higher cost than term life insurance. Variable universal life policies typically cost more in exchange for cash value and premium payment flexibility.

• More complex than term insurance. Variable universal life’s complexity can make using it more challenging. Before buying a variable universal life policy, be sure to clearly understand the goals you're trying to achieve.

• Cash value isn’t as easy to access as your checking account. You might pay fees or taxes when you access the cash value of a variable universal life policy. Removing money will also lower the value of your death benefit. Removing too much money can terminate your coverage entirely. It can also make it take longer to meet your life insurance contract goals. Always talk with a financial advisor before altering planned contributions.

• Investments involve risk. If you invest the cash value of your life insurance in market-based investment options, that cash value will be subject to market cycles and investment risks. If your investments perform poorly, you could lose your gains and initial investment. There’s the added risk that you could lose your life insurance as well—including the death benefit you initially bought it for.

• Flexible payments have limitations. You’ll want to be mindful about speeding up or slowing down contributions to your life insurance. When you reduce premium payments, this will affect the future cash value of your life insurance. Reducing premium payments can make it take longer to meet your life insurance policy goals. Always talk with a financial advisor before altering planned contributions. Also, note that adding a large lump sum to your life insurance policy can result in the IRS reclassifying it as a modified endowment contract. These contracts have different tax-time rules than standard life insurance.⁴

There is usually no direct cost to convert term life insurance to a permanent policy. However, your premium payments will likely be higher.

You may be able to convert all or some of your term life insurance to permanent life insurance. If you choose a total conversion, the amount of your new coverage will be the same as you had for term insurance. For example, if you have a $250,000 death benefit through your term life insurance, your new permanent life insurance contract would also be $250,000.

If you choose a partial conversion, you’ll convert just part of your existing life insurance. When you’re done, you’ll have stacked life insurance coverage—with both a term policy and a permanent policy active at the same time. This usually costs less in the long term than having permanent life insurance alone, because you still have some term coverage active. For example, if you have a $250,000 death benefit through your term life insurance, you could use $150,000 for your new permanent life insurance. And keep the other $100,000 of your death benefit with your existing term life coverage.

Ready to learn more about your life insurance options? Connect with a financial advisor near you.