Keeping an inexpensive term life insurance policy for too long can cost unprepared families lots of money in the long run.
While term insurance is a great way to protect your family from financial disaster, sitting on the same policy until it is too late to replace it with a permanent options can be a financial disaster.
Term life is temporary insurance. It pays a fixed death benefit if the policy holder passes away during a set period of time. For example, if you have a 20-year term policy and you die before the 20 years end, your beneficiaries will receive the face value of your policy.
Once the 20 years is up, the contract expires. The company keeps your premiums and you have to find new insurance, usually at a higher premium. Term insurance helps you to prepare for the unexpected.
Term insurance is the cheapest form of life insurance because it is temporary and not intended to pay out. Young families benefit from term insurance. In many cases, it is taken out to help support young children and a spouse in case the primary breadwinner passes away. That takes a large policy to accomplish.
Many young adults do not have substantial savings and investments yet. They have a lot of their money tied up in new mortgages and student loans. Term policies offer a cost-efficient solution.
But as families mature, the breadwinners grow older and the policies get closer to expiration. Situations change and families need to consider changing their term insurance into a more permanent option.
Many term insurance contracts have a clause that allows the policy holder to do just that.
You could think of it as leasing insurance with an option to buy. You can use the convertibility clause to convert without having to obtain a new insurance policy. For a price, families can transform their temporary insurance into permanent insurance without having to re-apply for coverage or have medical examinations.
Not all policies have conversion clauses. If you are buying term insurance, look for policies that include the clause. They are often more expensive, but well worth it.
For example, you have a 20-year term policy with a 10-year conversion clause. After nine years, you develop a major health problem. You are still within the 10-year conversion period, so you can convert the policy to a permanent policy. By doing so, you will not need a new physical exam and you will receive your coverage at a much lower rate than if your health problems were taken into account.
If the policy didn’t have the conversion clause, you would be facing an expiring policy and very expensive renewal premiums – if you could renew at all. You should always convert before it is too late.
You should review your policy with your agent on a regular basis. This will help to prevent that your conversion expiration doesn’t sneak up on you. When you are within a year of convertibility, you should take the time to look at your plan. Consider your health, finances, responsibilities and goals.
Don’t just look at your health in considering whether or not to convert a policy. The older you are, the more expensive you are to insure. By locking in a fixed rate and paying toward a permanent policy in your 20s, your monthly premiums will be much cheaper than if you had waited until your 50s.
Your financial needs transform over time. Your family matures and changes. When you are young, you often need a policy to replace your income and provide for your children. When you are older and your children are grown and your mortgage is paid off, you may find that you don’t need such a large policy.
The roughest rule of thumb is to take a multiple of your income. If you only need enough insurance to take care of your family for a few years after you die and set them up until they can get on their feet, buy 4-6 times your annual salary. If you want to take care of them for the rest of their lives, you can look at something quite larger, like 20 times your salary. That gives enough to establish a trust that they can life off of indefinitely.
One strategy involves buying the largest term policy you can afford when you are young. When you can afford more, supplement your term policy with a small permanent policy.
When your term insurance is set to expire, your children will be grown and your mortgage paid off. Then you can look at what coverage you will need.
