Is your term life insurance policy premium going a lot higher now that it's up for renewal? Do you want to find a way to keep your high rate class rating from long ago for your new life insurance policy in order to save money? There's a partial solution!
To keep your old rate class from years ago, convert your term life insurance policy into a permanent life insurance policy.
Life insurance is priced based on your age and your health. The older and less healthy you get, the higher your life insurance premium. There's nothing you can do about getting older.
But to keep your old health rating from 5, 10, 20+ years ago, no matter how unhealthy you get, you get to keep it if you convert to a permanent life insurance policy.
I couldn't believe it, so I checked with my life insurance carrier myself. I have a 10-year term life insurance policy that's running out and wanted to renew it.
Unfortunately, my policy was going to go up from $40 to $400. When I asked them if I could keep my same Preferred Plus (top) rating by converting to a universal life insurance policy, they said yes.
Understand The Different Life Insurance Rate Classes
As the father of a three-year-old and a five-month-old, I'm excited to be able to have the option to have continued life insurance coverage based on my Preferred Plus rate at least until they graduate from college or become financially independent adults.
Know that there are four health ratings in life insurance:
- Preferred Plus
- Preferred
- Standard Plus
- Standard
Standard is really a rate class you don't want to be in. Standard includes people who have chronic health issues like hypertension, obesity, high cholesterol, and so forth.
There's also Preferred Smoker and Smoker rate classes. You don't want to be classified as either of these classes. The easiest way not to is to not smoke.
To get the best life insurance rate, you want to be rated in the Preferred Plus class. But when I went to renew, I had dropped down to the Preferred class due to some sleep apnea issues.
Let's first look at the benefits of a permanent life insurance policy.
Permanent Life Insurance Features
1) Life insurance for life
Instead of having a term policy that has an expiration date, permanent life insurance covers your entire life so long as premiums are paid. Having a permanent life insurance policy helps provide peace of mind through all stages of life, whether you are just starting out, raising a family, or living in retirement.
With a permanent life insurance policy, you won't have to worry about all the different curve balls life may throw your way.
2) Different options
There are many types of permanent life insurance types. Here are four below:
- Universal Life (most conservative)
- Variable Life (more aggressive)
- Variable Universal Life (hybrid)
- Indexed Universal Life (hybrid)
The main difference in all these types of permanent life insurance policies is how the cash value portion is invested. The cash value is the portion of a permanent life insurance policy that gets built up over time based on the premiums you pay.
When you have enough cash value built up, you can even stop paying premiums by using your cash value to keep the policy active.
3) Cash Value Accumulation
Permanent life insurance provides a cash account that can supplement education and retirement needs while benefiting from tax-deferred growth (similar to a 401(k)) at competitive interest rates.
The cash value is the main difference that differentiates a term life insurance policy from a permanent life insurance policy. The premiums you pay for a permanent life insurance policy go towards paying for the death benefit amount and the cash value.
Given the tax-advantageous growth of the cash value, getting a permanent life insurance policy is another way for people to build wealth and manage their estates.
What's The Catch To Converting?
If you can keep your health rate class from years ago, why wouldn't everybody convert to a permanent life insurance policy from a term life insurance policy?
The three main reasons are:
- Not knowing there's an option
- Not understanding how a permanent life insurance policy works
- Higher cost
You can think about a term life insurance policy similar to paying rent for an apartment. Your rent pays for shelter each month and nothing more. Once the lease is over, you can either extend your lease or move out if you no longer desire to pay the rent. You do not build equity with rent.
A permanent life insurance policy is kind of like paying an amortizing mortgage. Part of your mortgage payment goes to paying down principal and building equity (cash value) and the remaining portion goes to paying interest (the death benefit). Over time, your cash value (equity) grows as it is reinvested.
When you have to also pay to build up your cash value, permanent life insurance premiums are much higher.
Cost Of A Permanent Life Insurance Policy
Below is an example of an “option A” universal life insurance policy (a type of permanent life insurance policy). This policy is what I'll get if I convert 100% of my $1 million term life insurance policy into a universal life insurance policy and keep my same Preferred Plus rating.
To reduce my premium, I can convert a smaller portion of the $1 million term policy into a permanent life insurance policy and keep the remaining death benefit amount until my term life insurance policy runs out in 2023.
But for the purpose of this example, let's keep the policy at $1 million and see the results from the benefit growth chart.
As you can see from the chart, my universal life insurance policy will cost $958/month! That's obviously much higher than my existing $40/month, so why the heck would I go this route?
The main reasons are as mentioned above: 1) building up the cash value, 2) having a permanent life insurance policy, and 3) being able to get the best premium rate based on my Preferred Plus 2013 health exam and not my suboptimal 2017 health examination.
Although my monthly premium is $958/month, $640/month of that amount is used towards building my cash value. Therefore, you can say my monthly life insurance premium to cover the death benefit is only $318/month compared to the $450/month I was quoted in 2017 when I tried to renew.
I'm guessing if I check with my existing life insurance provider again with a medical exam, my new $1 million term life insurance renewal premium might be over $550/month. Therefore, converting to a universal life insurance policy might actually save me over $200/month in death benefit coverage.
But to say that my life insurance premium is only $318/month is understating the value of this permanent life insurance policy due to the potential of tax-deferred growth in the cash value, the guaranteed minimum rate of return, plus the fixed monthly premium cost for the rest of my life.
This universal life insurance plan has a guaranteed minimum 2% annual rate of return on the cash value. 2% compares favorably with the 10-year bond yield at under 0.8% and the Fed Funds rate at 0% – 0.125%. The best online bank interest rate you can get currently is under 1%. Remember, everything is relative when it comes to finance.
Further, there is the potential for the cash value to return greater than a 2% annual return. The current rate of return for the cash value is 4.25%, which at one point, compared very favorably when the S&P 500 was down 32% in March 2020.
In the below chart, take a look at the growth of the cash value based on a 2%, 3.12%, and 4.25% annual rate of return.
As you can see from the chart above, over time, the cash value really starts to compound. The cash value can be used to boost the death benefit, generate an income stream, pay for the universal life insurance premium, or be taken out as a loan.
However, there is one big issue with “Option A” universal life insurance. If you die, your beneficiaries only get the death benefit amount of $1 million and none of the remaining cash value! The remaining cash value is kept by your life insurer.
To avoid having the life insurance company keep all your accumulated cash value, you should call up your life insurance company and see if you can exchange the cash value for a higher death benefit. Ask them what other options you have for using the cash value before death.
The other option for those who want their beneficiaries to keep the cash value is to choose “Option B” universal life insurance.
Option B Permanent Life Insurance
With “Option B” universal life insurance, your beneficiaries will receive your death benefit and accumulated cash value. Of course, there is no free lunch. Option B premiums are even higher. Let's look at the information below.
With Option B, my monthly premium goes up to an impressive $1,660. $1,291 of the $1,660 goes towards building cash value. Therefore, the cost of the $1 million death benefit is $369/month on average for the first year. Despite the much higher premium, I never have to worry about losing all the cash value. Instead, all the cash value will go to my beneficiaries.
Below is a table that shows the growth of the cash value using a 2% return, 3.12% return, and a 4.25% return. The death benefit columns are now the summation of the $1 million death benefit plus accumulated cash value. After 40 years, the cash value grows to over $1 million, meaning if I die at 82, I will leave over $2 million to my beneficiaries, tax-free.
Who Is Most Suitable For Permanent Life Insurance?
Given the cost of a permanent life insurance policy, even if you can keep your excellent rate class from years ago, it's not for everyone.
Most people will just get a term life insurance policy, which is the most efficient and cost-effective way to go. There are just incidences, where life changes, health changes, and needs changes beyond the term limit.
My favorite way to get an affordable term life insurance policy is with PolicyGenius, a life insurance marketplace that matches the best life insurance offers based on your application.
For those who are still considering a permanent life insurance policy, you should probably fit one of these profiles:
- Parents with lifelong dependents, e.g. a child with down syndrome or severe cerebral palsy.
- Parents who have gone through a difficult life and want lifelong peace of mind for themselves and for their beneficiaries.
- Parents or debtors who work in hazardous industries with unknown future health risks.
- Parents or debtors who have a higher-than-average income to be able to comfortably afford higher premiums.
- People who plan to have a much higher net worth and want to conduct estate planning to minimize taxes upon death.
- People who contribute the maximum to their 401(k) and other tax-advantageous retirement accounts and want another way to grow wealth in a tax-advantageous manner.
- People who don't plan to grow their estates far beyond what the estimated estate tax exemption amount is when they die.
If at least a couple of these conditions pertain to you, getting a permanent life insurance plan or converting your term life insurance plan to a permanent life insurance plan may make sense. Otherwise, going with the plain vanilla term life insurance plan is your best bet.
Solve Your Term Life Insurance Premium Problem Pragmatically
Although a life insurance policy is an act of kindness for my family, a life insurance policy also provides you peace of mind if something bad were to happen.
I totally understand how frustrating it is to lose your higher health rate class when you want to renew your life insurance policy. Being able to convert your term life into a permanent life is like going back in time. It also feels like cheating if you've gotten extremely unhealthy during the time you've had the term life policy.
However, getting a term life insurance policy is good enough, even if you don't get your previous higher rate class. The monthly premium cost will likely be lower. This time, just make sure you get a long enough term so you don't have to renew again.
You can apply with well-known providers one-by-one, or you can go through PolicyGenius and have qualified providers vie for your business.