Life insurance doesn’t have to be an either/or decision. Too often in debates about whole life insurance versus term insurance, and which is the better option, we forget that both work for different reasons! And having one type of insurance doesn’t disqualify you from another type. In fact, there’s a third option that may make both even more accessible.
Whole Life and Term Insurance, Defined
Term insurance is insurance that is purchased for a term of your life. Often 10 or 15 years and is often used in instances where people become parents and want a bit of protection. It’s highly affordable, because it’s short term, meaning that families can get more death benefit coverage for lower premiums. However, this type of insurance rarely pays out because they expire during the lowest risk periods of people’s lives.
And while we’re thrilled that so few families have had their term insurance pay out, from a fiscal standpoint, it’s kind of like renting an apartment. At the end of the lease, you don’t see that money back ever again. Term insurance is effectively an “if” product, not a “when” product.
On the other hand, whole life insurance covers your whole life—so long as you pay your premiums and keep the policy in-force. Consider it “when” insurance—it covers your death when it happens because it’s permanent insurance. There are other components, too, that contribute to its value. You can build liquidity in your policy, in the form of a cash value. It’s like building equity in your home, except you don’t have to get permission from the bank (or anyone) to access it.
Whole life with a mutual company can also earn dividends and provide tax benefits–way beyond what term insurance can do.
So, which is better? You’re likely to hear strong opinions in favor of either–however, options are more varied than you think.
Although we frequently advocate for whole life insurance…we feel just as strongly that term insurance is great for bridging the gap when it comes to being “fully” insured.
Renting to Own with Convertible Term Insurance
In this house analogy, if term insurance is like renting and whole life insurance is like owning a home, shouldn’t there be a rent-to-own option? The answer, actually, is yes. There is a “rent-to-own” option. And it’s called convertible term insurance.
Convertible term insurance is a type of insurance that allows the policy owner to buy term insurance and later convert to whole life insurance. This is a great option for people who aren’t sure where to start, because it locks in your insurability. So, for example, if you want whole life insurance, but aren’t sure if you can afford the premiums, you can start with a convertible term insurance policy. Then, maybe a few years down the road, can convert it to a whole life policy, without needing to re-qualify. That means that if your health changes, or another scenario that may affect your insurability, you can still get whole life insurance.
Convertible term insurance is great if you:
- Want to lock in your insurability while your health is guaranteed
- Know you want whole life, yet are on a “term budget”
- Already have a whole life policy and want to ensure that you can buy more when the time is right
- Want to protect your growing income and assets
- Have, or expect, children who will receive an inheritance
- Want a place to store cash in the future
- Want more death benefit, yet don’t currently have the budget for more whole life
What to Know About Convertible Term Insurance
1. Insurability is locked in
We cannot stress the importance of this—we’ve unfortunately seen how waiting to purchase insurance can do for a person’s eligibility. Life is unpredictable, and a person who is in perfect health today, may not be in a few years’ time.
Just like you cannot purchase home insurance for a house that’s on fire, you cannot purchase insurance when your health is declining. If you think you may want whole life insurance now or 10 years down the road, the best thing you can do for yourself is to lock in your insurability now. That way, no matter your health status, you can still get the benefits of whole life one day.
2. Conversion must occur within a certain time frame
It’s important to note that policies must typically be converted within a certain time frame. For a 20-year term policy, for example, conversions must usually occur within the first ten years. Before you lock it in, make sure you understand how much time you have to convert, and consider your personal trajectory.
3. You can also convert a portion of your policy
You don’t actually have to convert the whole policy if you don’t wish. For example, you may have $1 million death benefit, and only wish for $500,000 of whole life insurance because of the cost. You can even convert a portion of the policy each year over a few years if you wish. Don’t let future whole life premiums hold you back from choosing a higher term policy, as there are ways you can make it work for your budget.
Do note, however, that there is often a minimum term insurance level. For example, a company may have a $200,000 minimum term insurance limit. If you purchase that minimum and only convert a portion of it to whole life insurance, you could lose the remaining term insurance because it doesn’t meet the minimum. Whereas, if you convert half of a $1 million policy, you will still have $500,000 worth of term insurance.
4. Make sure you insure your “Human Life Value”
Contrary to some commentary, you can’t actually “over-insure” yourself. The company will only give you insurance up to a certain maximum based on your income. This is your full “human life value.” This is your economic value, often 15-20 times your income, or even 30 times greater for a business owner.
This figure represents a full income replacement over a person’s lifetime, which is why we recommend trying to insure up to this value.
Some advisors will recommend a “needs analysis” approach when determining how much insurance you should get, although we think this misses the mark. It’s based on how much money your family will “need” to replace your income. We think that ultimately this can short-change your surviving heirs, because it’s limited to the bare bones. Not to mention, it doesn’t typically account for inflation or other factors that might spread the money thin.
Insurance companies use HLV to determine a maximum limit for you, so we believe that you should insure yourself up to that limit if possible—through a combination of whole life and term insurance if necessary. After all, the companies won’t allow you to over insure yourself.
5. Convertible term is competitively priced
While convertible term policies are slightly more expensive than regular term insurance, it’s still extremely reasonably priced. Especially because you can lock in your insurability, even in the case of illness or disability.
In addition, some of your premium costs can even roll into your new whole life premiums when you convert. It’s a more cost-effective strategy than people realize. So if you’re delaying a policy simply due to cost, we recommend convertible term—especially if you intend on getting term insurance anyway, you might as well give yourself the flexibility.
The False Dichotomy
The question at hand, ultimately, is a false dichotomy. You don’t actually have to choose between types of insurance. You can have any combination of policies that you wish up to your human life value. You could have 20 small policies, if you so choose—some whole life, and some term insurance. They can and do coexist, and can actually help you create the best possible (i.e. most flexible) financial strategy possible.
Don’t choose between now or later—you can obtain the insurance you seek today, and lock in the benefits now, even on a budget. And it’s easier than you think!
While you must be relatively healthy to qualify, however the exam is fast and hassle-free. Not to mention, actually free. A physician can come to your house and do a quick evaluation, including measuring and weighing, as well as a blood draw. With the paperwork, which an advisor will help you with, you can have a policy in 4-8 weeks.