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Return of premium life insurance is a type of term life insurance, meaning it’s a policy that lasts a set period of time and then expires. Unlike other forms of term life insurance, however, return of premium offers opportunity to receive your money back at the end of the term.
Whether or not a return of premium life insurance policy is worth it depends on your individual financial situation and goals. Receiving a sizable chunk of money when you’re at or nearing retirement is nice, especially if you don’t have to pay taxes on it. But you have to consider you’re really just getting back money you already put in. It’s not extra money; it’s money that was already yours. It's also money that's lost out on years of compound interest, so it's worth less than it would have been if it was invested.
Getting a premium refund tax-free is enticing. After all, a lot of our financial decisions revolve around lessening our tax burden. But you shouldn’t let that blind you to the flip side of a return of premium policy. You have to take into account not just the tax implications, but the upfront cost (higher premiums) and opportunity costs (missing out on better investment vehicles) that come with them.
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 life insurance company reviews.
Return of premium is a modified version of term life insurance. Because it comes with a “money back guarantee” if you outlive the policy, it’s more expensive than typical term life insurance.
The average cost of return of premium life insurance is usually about 30% higher than basic term life insurance.
Here's an example:
|DEATH BENEFIT||ANNUAL PAYMENT||MONTHLY PAYMENT|
|$100,000||$155/ year||$13/ mo|
|$250,000||$240/ year||$20/ mo|
|$500,000||$387/ year||$34/ mo|
|$1,000,000||$695/ year||$60/ mo|
Methodology: Sample based on lowest cost average from top carriers for a 30 year-old male in highest health classification in the New Jersey area.
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The most obvious pro of a return of premium feature is the refund of the premium. Life insurance is important, but it can feel good to get that money back if you end up not needing the policy.
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. And as mentioned, since the return is considered a refund and not a payment, it's not taxable.
Learn more about life insurance and taxes.
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 aren't 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 lower cost than whole life insurance policies for people who aren't disciplined enough or comfortable with investing on their own.
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 rider is a modification or addition to a life insurance policy designed to give the policyholder either flexibility or extra coverage to protect against life’s uncertainties. Availability varies by carrier, but here are some common types of riders you may want to explore:
Provides monthly payments to replace your income if you become disabled or unable to work. This acts the same way as disability insurance, so some shoppers choose to add it as a rider to their life insurance and avoid buying a second policy to protect against disability.
In the event that you become disabled and lose your income as a result, this rider will allow you to skip paying your premiums until you recover without your policy getting cancelled or interrupted.
In the event you become terminally ill, this acceleration rider will allow you to access part or all of the death benefit cash, and use it to pay for certain expenses like medical care. A terminal prognosis usually means being diagnosed with 12 months to live, but can be 24 months in some states.
Most life insurance applications include a medical exam to help the carrier assess your risk of dying during the term of the policy. A no medical exam policy, such as a simplified issue or accelerated underwriting policy, will allow you to skip the medical exam if you qualify.
Mortgage life insurance is intended to pay for your home if you die during the course of the policy. This insurance mirrors the amount you owe on your mortgage, which declines over time. Usually offered at 15 and 30 years, the death benefit declines gradually and expires when you pay off your loan.
A more basic version of term life insurance than return of premium insurance. Level term acts exactly the same way as return of premium life insurance, except it doesn’t return the money you’ve paid in premiums at the end of the term. Premiums are therefore cheaper throughout the policy term.
The other main type of life insurance aside from term life is called permanent life insurance. Permanent life insurance policies last your entire life and include a savings component called cash value that builds over the course of your life. There are a few different kinds of permanent life insurance such as whole life, universal life and variable life which all offer slightly different features. They’re all more expensive than term life insurance for the same coverage amount.
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