When it comes to life insurance, one of the main questions potential policyholders have is “What happens to all my premium payments should I outlive my policy?”. After all, a 30-year term life insurance policy can cost anywhere from $7k to $20k over the term on the policy, and it can be frustrating to lose out on all that money. Below we will discuss return of premium life insurance options.
How a Return Works: Term vs. Permanent Life Insurance
In a standard term insurance policy (historically the most popular type of life insurance) a policyholder receives none of death benefit should they outlive the term, and there is no return of premium in any form. In order to address this, life insurance companies offer permanent life insurance policies – such as universal and whole life policies – which allow policyholders to build cash value. This cash value is accessible anytime during the term of the policy, and the policyholder always has the option to redeem their cash value in exchange for their death benefit.
The downside of permanent life insurance is that in order to provide cash value to the insured and still be profitable to life insurance companies, premium payments are very high – sometimes 5-10x that of a traditional term policy. For instance a 30-year old nonsmoker in excellent health, could receive a coverage amount of $500k for only $24 a month in a 30 year term policy, while the same coverage could cost them roughly $400 a month in a whole life insurance policy.
In order to split the difference between term insurance policies with no return, and whole life policies with very high premium payments, life insurance companies offer what is known as return of premium term life policies, or ROP policies. In a return of premium policy, a policyholder is covered for the term of their policy, and gets all their premium payments back at the end of their term, tax free.
Insurance companies offer this as both standalone return of premium policies, and ROP riders on a traditional term life insurance policy. Both offer you back 100% of the money you put in, and are functionally very similar. However it’s worth noting that there are sometimes fees and additional riders on the policies that will not be refunded. While these typically are a small percentage of what you’re paying, it’s always important to check with your insurance agent on the exact details of your return of premium rider or policy.
Return of Premium Life Insurance Pros and Cons
At this point you may be wondering, “I can get full life insurance coverage and my money back? Why wouldn’t I do this?”
The main argument against return of premium life insurance is opportunity cost. When evaluating permanent vs. term life insurance policies there is a common saying, “buy term and invest the rest”. What this means is you can often make more money by investing the difference between a term life and permanent life policy payments, than if you invest that same money into the cash value of a policy with higher premiums.
The same can be said for return of premium term policies, which on average cost 30% more than an equivalent standard term life policy. This is best illustrated through an example.
Let’s say a term life policy costs $384 and the equivalent return of premium policy costs $500 a year. At the end of a 20 year term, the ROP policy will give you $10,000 back, whereas investing that $116 difference in mutual fund or other investment platform could net you $12,000 to $21,000, assuming standard growth rates of 7-12%. As they say, there is no more powerful force in the universe than compound interest.
The other downside to higher premiums is less liquidity. Many prefer to maximize their immediate cash flow, and while a 30% might not seem like a huge dent, for an expensive term life policy (such as with older policyholders), it could amount to hundreds of dollars in additional costs per year.
A return of premium policy can make sense in an instance where an individual has a very low risk tolerance. Taking the figures from above, if $116 is invested in riskless investments such as savings accounts or certificates of deposit, they will only generate $5,000 to $7,500 – less than ROP term policy over the same time. Some may also prefer the ease of not having to continuously reinvest their savings every year.
Is Return of Premium Life Insurance Worth It?
As is true of most personal finance products, whether or not a return of premium policy is right for you depends on your personal situation, and is best answered a personal by a financial advisor and insurance agent. The best guideline we can offer is if you are an individual with an average risk tolerance and premium payments, it’s probably in your best financial interest to get a standard term life life insurance policy instead of a return on premium term life policy, and invest the difference. If you prefer no risk, and like to have fixed cash amounts for planning, a return of premium policy may make sense for you.
In general, it’s best to keep in mind that life insurance is vehicle designed to give your family coverage in the event of your untimely passing, and it should be prioritized as such. While individuals may on occasion wish to spread out their savings through different investment vehicles for tax reasons, your primary concern with life insurance should usually be maximizing the ratio of your death benefit to premium payment.