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Convertible Life Insurance

What is Convertible Life Insurance?

Convertible life insurance, also called convertible insurance, is a type of term life insurance that allows the policy owner to convert the term coverage into permanent coverage without undergoing a new underwriting process.

Understanding term vs. permanent life insurance

To understand convertible insurance, it’s first helpful to understand what you would be converting between.

All convertible life insurance starts as term life insurance. These are policies with the terms locked in for a certain length of time (e.g., 10 years, 30 years). During that policy term, the policy owner pays a fixed premium in exchange for a fixed death benefit should the insured die. Term life insurance is much more affordable than permanent life insurance.

At the end of the policy term, the specifications associated with the policy expire. The policy owner can decide to maintain coverage, but they should brace for more expensive premiums.

Permanent life insurance, on the other hand, costs more on the front end but lasts the insured’s lifetime. It also includes a cash value component, which operates like a savings account within the policy.

How conversion works

Many term life insurance policies are convertible insurance. That means that, per the specifications laid out by the policy, the policy owner can convert the term coverage into permanent coverage at the time of their choosing. The new permanent policy will be issued by the same insurer.

With a convertible policy, the insured doesn’t need to undergo a new underwriting process. That means no medical exam. So if a serious health condition popped up in the time since you bought your policy, you won’t need to worry that it could disqualify you for coverage.

But there’s one important thing to know: your premiums will cost more. Dollar for dollar of death benefit, permanent coverage is always more expensive because it lasts the insured’s lifetime and comes with a cash value component in the policy.

It’s also important to know that the conversion option usually comes with terms. You may only be able to exercise it up to a certain age.

How Does Conversion of a Term Policy Work?

Generally, there are 2 types of conversion available in the market:

  1. Original age term conversion

  2. Attained age term conversion

Original Age Term Conversion

This option is very rarely done. It allows for converting the policy based on not only the health class but also the original policy purchase age. It is a great option as it provides you with a policy that is already thriving. However, there are two downsides.

First, it often makes the policy into a MEC (Modified Endowment Contract) and thus it loses a lot of its tax benefits.

Second, and the main reason why this option is seldomly selected, it requires back paying all the premiums, as if the policy had been purchased at the original purchase date of the term policy, plus interest.

If you purchased a term policy in 2011 and in 2021 decided to convert it at your original age, the following equation would be made:

  • How much did you pay into the term policy so far?

  • What would the premiums have been, had you started your whole life policy 10 years ago?

  • What interest rate would be charged?

As you might assume, this can equal an astronomical sum. Though, there is a silver lining to this option.

You do have the full cash value as if your policy started on the original date of your term purchase. You can, therefore, take loans and withdrawals right away. One strategy is to actually use the money in the cash value to pay for the missing premiums.

Attained Age Term Conversion

The main benefit of this option is that you are not questioned regarding your health whatsoever. So, if you qualified for the best health class when you originally purchased your term policy, even if your health has deteriorated significantly, you will still get a permanent policy based on your initial health category.

A lot of people keep this option as a “Plan B” so that, if toward the end of their term, they see that requalifying for a new term policy at decent rates would be unlikely, they will instead convert or upgrade the term into a Whole life policy.

Many purchase Term Life Insurance with the intention of switching it into a whole life policy down the road as well.

Options with convertible life insurance

Convertible life insurance may come with the option to only convert part of the death benefit.

Say you know you’ll be done paying off your mortgage in 10 years. You might leave part of the policy untouched because the term extends past that point, then convert part of your death benefit to extend your lifetime. That way, if you decide not to renew your term policy once your financial burdens are lessened with the house paid in full, you’ll still have something to leave behind for your beneficiaries.

Some convertible life insurance policies also allow policy owners to use their age when they originally bought the policy, not their age now, when pricing the premiums for the permanent coverage. That can bring your premiums down significantly, but it usually requires a lump-sum payment.

Pros and cons of converting term life to whole life

There’s one major pro in the policy conversion column: once you convert your term policy to a permanent one, the coverage will last your lifetime with the new details in place. In other words, you no longer need to worry about a premium hike at a certain date.

Assuming your budget can continue to accommodate your premiums, you’ll have no trouble maintaining your coverage. And that means that whenever you pass away, your beneficiaries will get the policy’s death benefit, ensuring their financial comfort and easing the transition to life without you.

Some other pros of life insurance conversion include:

  • The ability to get a permanent policy without medical underwriting (in other words, you won’t need to go in for a medical exam)

  • The flexibility to convert (within policy terms) when the time is right for you

  • The big con of policy conversion is that it costs more. Term life insurance is always cheaper than permanent life insurance. So when you convert your term policy, you need to be prepared to pay premiums that are higher than if you stuck with term coverage.

In fact, cost is an overall con of convertible insurance, even if you don’t decide to convert your policy. Because it builds in the option to turn your term coverage permanent, convertible term insurance costs more than term policies without a conversion option.

When can you convert your policy

Most companies allow for the conversion of Term policies into Whole or Universal Life from day one. There are some companies that require waiting a year, but that is not typical.

The ability to convert expires at varying stages depending on the company and policy. Some offer the privilege until a set age at, for example, 65 or 70. Others place the limitation on policy years such as five or 10 years into the policy. Many companies allow you to extend this right by purchasing a rider for a nominal monthly amount.

You do not, and probably shouldn’t, wait until your term policy is about to expire to look into the conversion options available on your policy, as the option may expire or, at the very least, cost more in the later policy years. It should be a discussion you have with your advisor while purchasing your term policy. At Sproutt Life Insurance, we can advise on the various nuances and differences between the companies and their conversion limitations.

Conversion vs. portability

Conversion can sound a lot like portability because they both allow you to take existing coverage and adapt it. Plus, they can both apply to group life insurance, or life insurance coverage that you get through your employer. But they’re different policy features.

With group coverage, conversion works the same: you convert your term policy into a permanent life insurance policy.

With portability, however, you’re not changing the policy as much as taking it with you. With a portability option, you can keep the coverage in place even if you leave your employer or get fired.

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