Term life insurance: it’s pretty straightforward. You buy a policy, and if you die during the time it’s in force, your beneficiaries get paid out.
But what happens if you don’t die over the term of the policy?
That’s a hangup about life insurance for many people. On the one hand, congrats – you’re still alive. On the other hand, you just spent a few decades and a few thousand dollars on seemingly nothing.
Of course, you didn’t actually get nothing. You got peace of mind and a financial safety net for your family in a worst case scenario. But human psychology is a funny thing, and for some people it can feel like a waste of money.
That’s where return of premium life insurance comes in. Can you design a policy that gives you affordable protection and makes you feel good about the "value" you’re getting? We’ll take a look at this option and see when it comes in handy.
What is a return of premium life insurance policy?
If a return of premium (ROP) life insurance policy sounds like a life insurance policy that returns your premium to you, then you get the basics.
Just so we’re clear: a return of premium policy means that when the term of your policy is up and you’re still alive, you get the amount you put in as premiums returned to you, tax free. (It’s tax free because it’s basically a refund of money). If you paid $50 a month for a 10-year term, you get $6,000 back. This can either be sold as a return of premium policy or as a rider on a traditional term life insurance policy. You’ll typically get back 100% of the premium you paid – including the cost that you paid for an ROP rider – but fees and additional riders that are added to the policy above and beyond the ROP rider may or may not be included in the return. If you’re considering this type of policy, be sure to check with your agent on what exactly you’ll be getting back.
Regardless of how you get a return of premium benefit, you’ll be paying more for it. If it’s the policy itself, the monthly premiums will be higher; if you get a return of premium rider, the rider will add an additional cost. Overall, you’ll be looking at around a 30% markup in your monthly premiums.
That’s why, even though a money-back guarantee seems like a surefire win, it’s important to know when a return of premium is right for you.
What are the pros of a return of premium life insurance policy?
The most obvious pro of a return of premium feature is, well, the return of premium. Life insurance is important, but it can feel good to get that money back if you end up not needing the policy (which, to repeat, is the best outcome with life insurance!).
The fact that you can essentially get a refund is also great for people who want protection but have a low risk tolerance. We often think of life insurance as a "what if" need – "What if I die and am not around to support my family?" – but some people might think of it as "What if I put $10,000 into a life insurance policy that I don’t use, and then I don’t have that money for my retirement savings?" With a return of premium policy, you don’t have to make that choice anymore.
You can also view a return of premium policy as a forced savings vehicle. If you aren’t great with money and want to make sure you have something saved up later in life, an ROP term life insurance policy provides you protection for 20 or 30 years, and at the end of it you’re rewarded with the money you put into the policy. That feeds back into the risk aversion aspect: instead of playing the stock market, you get a guaranteed amount of money back down the line.
If you’ve heard this forced savings idea before when it comes to life insurance, that’s because it’s similar to the logic behind whole life insurance (and some ROP policies even have a cash-value component, which we’ll get into a bit more later). Generally, whole life insurance policies are almost never worth the cost for most people who just need pure life insurance. But since ROP policies are relatively less expensive, it can work as a forced savings vehicle at a fraction of the cost of whole life insurance policies for people who aren't disciplined enough or comfortable with investing on their own.
What are the cons of a return of premium life insurance policy?
But that doesn’t mean a return of premium life insurance policy is right for everyone. There’s no such thing as a free lunch, and getting back that money will cost you.
First, as mentioned, return of premium policies are more expensive than a basic term life insurance policy. That means you could be busting your life insurance budget by opting for a return of premium, and you might be better off doing something different with that money.
But let’s get into the forced savings aspect again. When talking about the difference between term life insurance (where the policy ends after a set amount of time) and whole life insurance (which lasts for as long as you pay premiums, but is more expensive) there’s a common piece of advice that you should "buy term and invest the difference." The logic goes that the main selling point of whole life insurance – that you get an insurance policy along with a cash-value component that acts as forced savings – is actually a poor decision, and you’d be better off buying a cheaper term life insurance policy and investing the money you save elsewhere with a better return and lower fees.
The same could be said about a return of premium policy. Rather than pay extra for the feature – again, around 30% more than with a standard policy – you could invest the difference and rather than get a guaranteed return with no upside, you can get a return thanks to a few decades’ worth of compound interest through something like an IRA or an investment platform like Betterment or Wealthfront. Even if some policies have a cash-value component, you run into the same problem as other cash-value policies like whole life insurance, where you may end up with a sub-optimal investment option. But, this isn’t an apples-to-apples comparison, since whole life insurance is usually significantly more expensive than term life insurance, whereas a return of premium policy is usually only slightly more expensive than a basic term policy (depending on your age and profile). And the refund of premium at the end of the term, net-net, could be worth it if you have high risk aversion and are a value-seeker.
Finally, you may be limited to the return of premium policies that are available to you. Certain insurers might only offer specific term lengths or minimum coverage amounts. This might not matter to you if the policies offered fit your needs, and you may find more flexibility with a return of premium rider that you can add to a wider variety of policies, but it’s something to keep in mind when you’re looking at policies that are available to you.
A return of premium life insurance policy can work for someone who can afford paying a little extra each month and wants a relatively low cost forced savings vehicle, but may not be right for someone who just needs a basic term life insurance policy to protect their family and is more budget-sensitive. If you’re wondering what life insurance companies offer return of premium policies and riders, be sure to check out our company reviews for the lowdown on all of the policies you can find on PolicyGenius, or talk to one of our licensed experts today.
Image: Ghost of Electricity