Have you considered your life insurance lately? Does the life insurance policy that you bought years ago still fit your family needs? If you have a term life insurance policy, it may make sense for you to consider switching it to a whole life policy under certain conditions – but what are those conditions?
Let's start by reviewing the difference between term and whole life policies.
Term life insurance policies are designed to provide protection for your family in case of your death – but only for the term stated in the policy (for example, 20 or 30 years). Aside from the benefits payable upon death, there are generally no other benefits included.
When the policy reaches maturity, the coverage ends and you stop paying premiums. Some term life policies will allow you to qualify automatically for a new term life policy after expiration. You won't have to take another medical exam, but your premiums will likely increase.
Whole life insurance costs more, but it is a permanent form of insurance with an investment component. As long as you pay the premiums, coverage generally stays in effect for your entire life (unless you live to age 95-121 depending on your policy). A portion of your premiums goes to cover death benefit obligations, while the rest is placed in some form of investment, building cash value.
As time goes on, your life insurance needs may change to make a whole life policy more suited to your situation. There are four typical reasons, along with variations on these themes:
- You could only afford a term policy on your initial purchase, and you now can afford the higher premiums of a whole life policy – and have decided that the return on a whole life policy is a better use of money than a term life policy with the difference in term and whole life policy premiums invested separately.
- You want to extend insurance beyond the original term policy and prefer to switch to whole life to avoid future policy changes (or, as in the above case, you like the investment aspect of a whole life policy).
- Your health is degrading to the point that you can't get an affordable policy when the term policy expires. By switching to a whole life policy, you will not have to take a medical exam to determine insurability.
- You think a permanent life policy would make life easier on others after you are gone, such as by providing trust funds for a special needs child or helping your heirs pay estate taxes.
To be able to switch, your term policy must be a convertible policy. Most are, but it's important to verify this with your insurer. Convertible policies generally have a limit on when they can be converted, driven by your age or the percentage of your policy remaining.
From a pure economic standpoint, if you plan to convert from term to whole life, it makes sense to do so early in the policy. Premiums for a whole life policy will increase as you age. However, you must consider whether the investment portion will meet your family needs. If you have other investments such as a 401(k) or IRA that are more growth-oriented, a whole life policy can fill the conservative space in your portfolio.
You may have good reason for converting your term life into a whole life policy, but understand all of the ramifications involved. Don't just accept a sales pitch. Make sure that you clearly define what you want out of a life insurance policy, and consider both the economic factors and risk/safety factors with all of your options.
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