Should I convert my term life insurance?
As one’s term policy nears its expiration date, plenty of people wonder what to do next. Should they let the policy expire? Convert the policy to whole life? Or purchase another term policy? There is no right or wrong answer – it is dependent on each situation and the objectives of the individual. Here are considerations to assist with making the decision:
- The difference between term and whole life insurance
- Why convert term life insurance?
- When to convert term insurance
- Next steps for an expiring policy
Understanding the Difference Between Term and Whole Life Insurance
The first step to deciding whether to convert term life insurance is understanding the difference between term and whole life. Term is temporary coverage that only lasts for a period of time – typically 10, 20 or 30 years. It is an affordable and convenient form of coverage. Whole life insurance provides policy owners with a guaranteed death benefit and can build cash value* over time. The premiums for whole life, however, are typically more costly than term insurance.
*Access to cash values through borrowing or partial surrenders will reduce the policy’s cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.
Reasons for Converting Term Life Insurance
Individuals typically convert their term life for three reasons.
The first reason is the health of the policy owner. If someone has a dramatic change in their health, this impacts their future insurability. They may want to convert their term potentially at the health rating they received when they took out the original policy.
The next reason is for retirement planning and leaving a legacy. The policy owner may want to ensure that they leave behind a certain amount to their spouse, children, and/or grandchildren regardless of when and how they spend their current nest egg.
A final reason to convert term life insurance is to build one’s assets. If an individual elects to view permanent insurance as a cash value building asset on their balance sheet, they would want to consider converting some of their term.
A whole life policy will provide a long term rate of return that should dramatically outperform cash but underperform stocks. It provides a consistent, stable return. There is room for this in a client’s portfolio as a diversifier or volatility buffer to complement their equity positions. Similarly, if through financial planning someone determines that they want to use their insurance policy to leave a legacy or provide liquidity at death – that is a definite driver to consider conversion.
When to Convert Term Insurance
Remember – one of the biggest factors if insurance cost is age. If someone is considering converting their term insurance, they may want to plan ahead and not wait until the end of their term policy. The younger an individual is when opting to own permanent insurance, the less costly it will be.
If a person experiences a positive change in their cash flow, they may want to consider converting their term life to whole life and using this as a supplemental savings tool to a 401(k) or a savings account. If someone experiences a change in their health, as previously mentioned, they certainly would want to take a second look at converting their term insurance as well.
Next Steps for an Expiring Policy
Generally speaking, a conversion of a term policy would involve no medical questions. While the paperwork varies by carrier – it tends to less than that of a traditional application. If someone is considering a conversion, the process is simple enough.
Nevertheless, one can also purchase another term policy. In general, someone should try to time their term to expire when their debts are paid and their dependents are grown. If the insurable need is no longer present or as large, the need for insurance should be diminished at that point.
Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.
Chris Kampitsis is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000