Why return of premium life insurance might be a better buy than whole life insurance
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Term life insurance is the best life insurance for most people. It provides a sufficient financial safety net at an affordable cost, and is straightforward so you know exactly what you’re getting.
Return of premium life insurance is a popular form of term life insurance. Return of premium does just what it says: when the term of the policy is over, the premiums are refunded to the policyholder, minus some negligible fees. It’s more expensive than a traditional term life insurance policy, but it comes with a money-back guarantee.
Another popular alternative is whole life insurance, a type of permanent life insurance policy that stays in effect for as long as the policyholder pays their premiums. It can work as a handy financial tool but it’s also more expensive than a term life insurance policy.
People who want more than a traditional term life insurance policy see that both of these are more pricey and think, "If I’m paying more, why don’t I just get the one that will last my whole life? Whole insurance seems like the better buy!"
But a return of premium policy still might be a better buy for someone trying to get more value for the cost. Here’s why.
Return of premium and whole life insurance policies aren’t just different for the sake of being different. They have benefits – or at least perceived benefits – and drawbacks compared to traditional term life insurance.
The biggest benefit to getting a return of premium life insurance policy is right in the name: you get the premiums returned to you.
Some people believe that life insurance is a waste of money if it never pays out, that they’ve put a lot of money into something and didn’t get anything tangible in return. That’s the wrong way to think about it for a few reasons.
First, it means you outlived your policy, which is good.
Second, you did get something: peace of mind that your financial obligations would be taken care of even if you weren’t around.
Finally, without life insurance, you’re assuming that nothing bad will happen to you or, at the very least, that your family would be able to cover all costs without your income contribution. Those are both big assumptions.
A return of premium policy can can help a policyholder feel better about their purchase by providing a financial return if you outlive the policy – a win-win. It’s technically money you’ve already paid and not "new" money, but it can be a nice boon in retirement to get a large sum of money back (like an extreme version of finding five dollars in a jacket pocket).
Whole life insurance, on the other hand, lasts for as long as you pay your premiums. That can provide a sense of ease that you’ll always be covered and your beneficiaries will receive something, no matter how long you live. The cash value aspect of whole life insurance also serves as a forced savings vehicle: Over time the insurer reduces its commitment to cover your death benefit as your cash value grows and eventually becomes big enough to cover the entire death benefit payout.
Of course, as with everything, there’s another side of the coin, and there are some negatives to both of these policies that term life insurance doesn’t have.
With a return of premium policy, you pay a little extra every month and get the money back at the end of the policy term – usually 20 or 30 years later. But think about what you could have done with that money in that period of time.
We’ll get into some numbers in a bit, but let’s say you’re paying $70 more a month than a traditional term life insurance policy for the privilege of getting that money returned. At the end of a 20-year term, that’s an extra $16,800. If you invested that money in a retirement account or in mutual funds, you’d have many times that, dwarfing the amount you "saved" by having the premiums refunded.
Whole life insurance has similar shortcomings. The cash value aspect typically doesn’t provide as high a return as other investment vehicles, you’re paying for a policy later in life when you likely don’t need it, and you could be doing a lot with the extra money you’re spending on the policy. That’s why many financial advisors have a philosophy of "buy term and invest the rest."
In the end, if you’re going to put some extra money into your life insurance policy, a return of premium policy provides a better value than a whole life insurance policy. You get an added benefit and it’s much, much cheaper.
Let’s look at an example.
A healthy 30-year-old man looking at a 20-year, $500,000 return of premium policy can buy one from AIG starting at around $91 a month. A woman can buy one for around $75 a month. Comparable policies for a man and woman from Prudential would cast around $101 and $88 a month, respectively.
Compare that to a whole life insurance policy from State Farm. A $500,000 policy for a healthy 30-year-old man is around $459 a month, and $409 for a woman.
Both policies cost more than a traditional term life insurance policy, but the price discrepancy is huge. An entire year of a return of premium policy costs the same as paying for only a few months of a whole life insurance.
Plus, you do get that money back in the end. Whole life insurance has an investment option but, again, you won’t see big returns with it. With a return of premium policy, you can still practice "buy term and invest the rest," investing the $300+ dollars you’re not putting into a whole life insurance policy each month and getting the premiums refunded.
At the end of the day, an affordable traditional term life insurance policy will be sufficient for most people’s needs. But if you want to get some extra value out of your policy and have to decide between a return of premium and whole life insurance policy, a return of premium policy may be the winner.
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