Have you ever heard of return of premium term life insurance? If you haven’t, you’re not alone.
Most insurance plans are purchased in the hopes of never having to use them. For example, just because you have health insurance doesn’t mean you want to get sick, and you don’t buy car insurance in the hopes of getting into an accident.
Life insurance is similar.
You don’t want to think about the purpose of the plan, but it will definitely help your beneficiaries at the time of your death. That is of course, unless you purchase term life insurance and outlive the policy.
With term life insurance, a person purchases a plan for a fixed period. If the policy holder passes away during the term period, the beneficiaries will be paid the death benefits. If the insured outlives the term period, the benefits are no longer in effect.
Paying into a life insurance policy that has a finite term is one of the arguments for buying for whole life insurance. Though there are times it makes sense to buy whole life insurance, in most cases, term life insurance is a better option than whole life insurance for many people. Most people buy life insurance to cover the period of time when they are at their peak earning potential with the goal of not needing life insurance when they reach retirement age.
Nevertheless, term life insurance is a popular option for individuals due to the affordability and protection offered during the term period. For individuals who want the benefits of term life insurance but do not want to risk paying premiums on insurance that may never pay out, return of premium life insurance may be a better option.
What is Return of Premium Term Life Insurance?
Return of premium life insurance basically provides the answer to the question, “what happens to all the money I’ve paid toward term life insurance if I outlive the term period?” With return of premium life insurance, if the insured does not pass away before the end of the term period, all of the premiums paid over that term will be returned.
How does return of premium term life insurance work?
To better understand how this policy works, consider the following examples of both term life insurance versus return of premium life insurance.
- Term life insurance. If the insured purchased a 30 year term life insurance policy at the age of 40 at a cost of $1,000 per year, they will pay out $30,000 over the period of the policy. If the insured lives past 70 years of age, the insurance policy expires and neither the insured nor the beneficiaries are owed a thing.
- Return of premium life insurance. If the same person chooses to purchase return of premium life insurance for the same period of time and they outlive the term, they are entitled to the full return of all premiums paid.
Is ROP life insurance a good deal for the consumer?
At first glance return of premium life insurance may seem like the obvious choice, whereas the insured has life insurance coverage over the term period, which if unused, costs them nothing.
The problem with this theory is return of premium life insurance is more expensive than your standard term life insurance policy for the same period. In some cases the same policy can cost up to 50% more over a 30 year period.
The difference in premiums is what allows the insurance firm to return all of the premiums because they have had the opportunity to invest the additional money over that 30 year period.
For this reason, it may make sense to purchase a standard term life insurance policy which provides the coverage you desire, while investing the difference in what you would have paid for return of premium life insurance. In this scenario you would still have the coverage while having the opportunity to earn interest on the difference.
You can make a similar analysis for buying other specialized life insurance policies, such as mortgage life insurance. Mortgage Life Insurance seems like a good idea on the surface, until you realize you are paying a fixed premium for decreasing benefits as you pay down your mortgage.
Whether or not return of premium insurance is a good deal is largely based on your risk tolerance and which type of policy feels more comfortable for you and your family.
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Doug Warshauer says
While you’d need to compare two specific policies to see what the premiums for each are and to calculate the implied interest rate on the ROP policy, it sounds like a gimmick to me. As you pointed out, you’re not really getting your money back because of inflation and forgone investment growth. Because it seems like a policy designed specifically to be misleading, I’d tend to shy away from buying it.
I agree, Doug. Most people would be better off investing the difference. The other thing I didn’t mention in the article is to read the terms carefully. Many of these policies contain clauses that state you will lose all premiums paid if you do not take the policy to term – so you wouldn’t receive anything back if you cancel your policy early.