It sounds like a life insurance buyer’s dream: you buy a 20-year term life insurance policy to protect your family when the kids are young. After they’ve graduated from college and live on their own, you decide you no longer need the policy and choose not to renew it. The insurance company then sends you a check returning every dollar you ever paid in premiums.
Sound too good to be true? It just might be.
In the scenario above, the 20-year term life insurance policy you bought is known as “Return of Premium Life Insurance (ROP).” It has its pros and cons, which we’ll look at in this article. You can then decide if it’s a good life insurance product for you and your family if you keep it for years.
It’s important to remember that, first and foremost, ROP life insurance is precisely that: life insurance. You buy it because someone will suffer a financial loss when you die, or you buy it to leave money behind as part of your legacy. The life insurance company agrees to pay your beneficiaries an agreed sum of money in return for monthly or annual premiums you pay them.
A return of premium life insurance policy is term life insurance – with one caveat. If you outlive the policy term, the insurer will return all of the premiums you paid them. Hence, it’s called “return of premium life insurance.”
Your premiums are paid back to you after a “term” of years, like 5, 10, 20, or 30 years if you keep paying for the policy until the end of the term. For that reason, almost all ROP life insurance policies are term life insurance policies, not permanent types of policies like whole life insurance or universal life insurance, which are typically purchased to provide you protection for the rest of your life.
Did you receive a credit from your auto insurance company at the height of the pandemic because you were driving a lot less than usual? If you did, it’s because your auto insurance company was paying out a lot less in claims than they usually would because of so many people working from home and staying off of the roads.
Return of premium life insurance works similarly. If you outlive the policy term, it means the life insurance company never had to pay out a death benefit to your beneficiaries, resulting in lower losses for them. In consideration of that, and agreed to contractually, they then must return to you 100% of the premiums you paid them – income tax-free.
It almost sounds like you had free insurance, but you didn’t. There is a trade-off: you paid handsomely to have the return of premium provision added to your basic term life insurance policy. As much as 200% or more, which is much higher than you would have paid without the ROP feature.
Different types of life insurance appeal to a variety of different kinds of people. Their selection can be due to family health history, income, financial needs of survivors, length of time the protection is needed, risk tolerance level, and more.
When selecting the best type of life insurance for your situation, you might be presented return of premium life insurance as an option. Here are some pluses and minuses of ROP life insurance to help you evaluate its viability for you.
Pros of ROP life insurance
- ROP term life insurance has a lower cost than permanent life insurance
- It can be a forced savings strategy if you do have your premiums returned
- Premiums returned to you are not taxable
- Some policies will let you convert from term life to permanent life insurance without a medical exam
- Some ROP policies do build cash value over time, from which you can take loans or withdrawals
Cons of ROP life insurance
- It’s much more expensive than traditional term insurance
- With many policies, you won’t be able to get your money back early; you have to pay premiums for the entire term for the insurer to return your premiums
- You may have to purchase a minimum amount of coverage, such as $100,000
- A limited number of companies offer ROP life insurance, leaving you with fewer options than other types of life insurance
The biggest negatives about ROP life insurance: the money returned to you will be credited zero interest from the life insurance company, and the value of the money returned is worth less than what you paid due to inflation. In effect, it’s like making an interest-free loan to the insurance company.
As we’ve mentioned, ROP life insurance sounds enticing, but how much extra will you pay for the benefit? Here’s an example of the difference in cost between an ROP policy versus basic term life insurance:
Terry, a healthy 40-year-old male, is interested in buying $100,000 of life insurance. His agent quotes him:
- $145 annually for a basic 20-year term life policy
- $499 annually for a 20-year ROP policy
That’s a 344% difference in premium.
Proponents of the life insurance strategy “buy term and invest the difference” point to examples like this to illustrate why they recommend basic term life insurance instead of other types of term life policies or permanent policies.
They suggest you take the difference in premium and invest it in something that will provide you with enough growth to provide a greater financial reward for you, such as a mutual fund. If you’re more conservative, an interest-bearing savings account is another alternative to consider.
A return of premium life insurance policy probably isn’t worth it for most people except those determined to get their money back after paying premiums for years, which never resulted in the insurance company paying out a penny in benefits.
If that’s the case for you, shop around and compare ROP policies. Be sure you understand what happens if you decide to cancel your policy before the term expires. If there’s a possibility you won’t need life insurance for decades, a traditional term life policy could be a better choice for you.
Having grown up in upstate New York, Bob Phillips spent over 15 years in the financial services world and has been making freelance writing contributions to blogs and websites since 2007. He resides in North Texas with his wife and Doberman puppy.
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