When a client’s health declines, converting term coverage to a permanent policy is often the smartest move they can make. If that policy is also headed to an irrevocable trust, the order of the two steps can change the value reported for the transfer and the cash or gift needed to make it happen.
Key takeaways
- Converting term to permanent coverage preserves insurability when a client’s health has declined.
- Transferring before or after conversion can produce different fair market values for gift or sale purposes.
- A lower value can keep a gift within annual exclusions or reduce the cash a grantor trust needs to buy the policy.
The order of the steps matters, and the right sequence usually turns on which approach produces the lower defensible value.
A common planning scenario
A client owns a personally held term policy. Their health has changed, so converting to permanent coverage without new underwriting is valuable. They also want the policy in an irrevocable life insurance trust (ILIT) to keep the death benefit out of their taxable estate, protect it from creditors, or manage it for heirs.
The question: convert first and then transfer, or transfer the term policy and let the trustee convert?
How each policy is valued
The answer usually depends on the fair market value (FMV) of the contract at the time of transfer:
- Term policy. An in-force level term policy is often valued using its interpolated terminal reserve plus any unearned premium. Level term does build a modest reserve because premiums stay flat while the cost of coverage rises.
- Newly converted permanent policy. In its first contract year, a new policy is often valued at the premiums paid.
Advisors often choose the sequence that produces the lower value. The carrier can provide the numbers, typically on IRS Form 712, and the client’s legal and tax advisors should confirm the approach.
Why a lower value helps
If the policy is gifted to the trust, a lower value may keep the gift within the annual exclusions available to the trust beneficiaries, which can avoid using lifetime exemption. Note that gifts of life insurance within three years of death can still be pulled back into the estate.
If the policy is sold to a grantor trust to avoid the three-year rule, a lower value means less cash has to be gifted to the trust to fund the purchase. A sale to the insured’s grantor trust is also generally protected from the transfer-for-value rule. For more on grantor trusts, see our post on grantor trust planning.
Let us help with the sequence
Conversion deadlines, carrier rules and trust documents all have to line up. Contact us when a case involves both a conversion and an ownership change. We’ll gather the valuation information for both policies and help the client’s attorney and CPA order the transactions correctly.
Frequently asked questions
Should a term policy be converted before or after transfer to an ILIT?
It depends on which sequence produces the lower defensible fair market value and fits the client’s goals. Compare the term policy’s value with the new permanent policy’s first-year value and confirm with legal and tax advisors.
How is the value of a term policy determined for gift purposes?
An in-force term policy is often valued at its interpolated terminal reserve plus unearned premium. The carrier can provide this figure, usually on IRS Form 712.
Why sell a policy to a grantor trust instead of gifting it?
A gift of a policy within three years of death can be included in the estate. A sale for full value to a grantor trust generally avoids that rule and is also generally protected from transfer-for-value taxation.
Reviewed by Tim Fuller on 2026-09-26
Tim Fuller
President, SRS Inc.
Tim leads SRS Inc., a full-service IMO (Independent Marketing Organization) and BGA (Brokerage General Agency), connecting independent financial professionals with life, annuity, disability income, and long-term care solutions from 60+ carrier partners.
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