Most physicians who buy term insurance are satisfied that they are paying less for their coverage than they would with a permanent life insurance plan. Still, many might feel that, after 20 or 30 years of paying into a policy without ever needing it, is like throwing money down the drain. Of course, their survivors wouldn’t feel the same way if it was actually needed. The life insurance industry responded with a plan that appeals to those who would find even more satisfaction if they actually received back all of the premium they paid into the policy making them feel as if they got something for nothing. Enter Return of Premium Life Insurance (ROP).
Return of Premium Life Insurance Basics
The concept of return of premium life insurance is very simple. It is nothing more than a regular 15, 20 or 30 year term policy with a fixed, level premium paid on a level death benefit. At the end of the term, and if you are still alive, the life insurer will return to you your entire premium. If the policy is canceled before the end of the term, you will only receive a partial return, such as 10% of premium paid after 10 years, or 25% after 20 years. Also, if your policy was rated where you had to pay an extra rate, or you added any riders, you won’t see a return of these added charges.
The big difference between regular term and ROP is the cost. Generally, the premiums paid on ROP are about three times higher. For instance, a 30 year old male who paid $220 a year for $500,000 of term coverage would pay as much as $660 for an ROP. Why the difference? Well, in order for the life insurer to be able to give you back your money after 20 or 30 years, they need to have been able to earn a return on that money as a cost for holding it for you. Make sense? Probably not, but they have somehow determined that this extra premium covers the cost of their risk while holding out the opportunity for you to receive your money back.
Is Return of Premium Life Insurance the Best Use of Your Money?
And that brings us to the main criticism of return of premium insurance, which is the opportunity you give up to earn a better return than 0% over those years. But that may be unfounded for two reasons. First, it assumes that you can earn a better rate on savings for the entire 30 years. Second, with a buy-term-save-the-difference strategy you are still giving up the term premium. After taking into account taxes, the ROP strategy may actually prove to be a better overall return.
In the above example, the person could have purchased a regular term policy and put the difference of $440 annually into a savings account. If it were invested annually for 30 years at 4% the resulting balance would be $20,835 after taxes (30% combined federal and state taxes) as compared with the return of premium which would total $19,800 a difference of about $1,000.
There are three big assumptions here that make the $1,000 advantage possible. The first is that you can actually earn an average rate of 4% a year for 30 years. The current savings rate is about 1%. The second, is that your tax rate doesn’t increase over that time. And, third, that you even manage to think about taking the $440 and actually putting it into savings as opposed to spending it. If any one of these assumptions fall short, then it’s possible that the ROP could actually outperform the buy-term-save-the-difference strategy.
Affordable: Generally still less expensive than permanent life insurance, although you might be able to find a universal life policy with rates fairly close to an ROP.
Double peace-of-mind: There’s nothing like the peace-of-mind knowing that you are getting peace-of-mind for free.
Easy to buy: It’s as easy as buying any other term policy. Shop and compare. Best course is to buy from a highly rated company.
No return on investment: While it’s true that you have given the life insurer free use of your money, at least you are getting a return of your investment which is more than some investors can say.
You can do better on your own: You can take the difference in premium and invest it in a high yielding savings account, mutual funds. Best course is to make sure you are maxing out your qualified plan contributions. But, the important thing is to remember to actually invest the difference, or you won’t do better.
Cancel early and you will lose: If you cancel before the end of the term you can still get a partial return of premium, but it is hefty price to pay considering the higher premium cost.
As with any life insurance decision, it is vitally important to do your homework, shop and compare. The amount of resources available on the internet makes that task very easy. Be sure to scratch out the numbers to see if return of premium life insurance might make better sense based on your own situation.