Return of Premium Life Insurance: Is It Worth the Extra Cost?

Ever pay for insurance—and hoped like crazy you never need to use the insurance. It’s a common feeling. You pay years of premiums for the protection of your family. But if you outlive your policy, then that money is gone. What if there was to be way to get it all back: This is the promise of Return of Premium Life Insurance. It sounds like a no-loss situation.

But is it really that simple?

As an insurance specialist with more than 10 years of dedicating my career to insurance, I’ve seen this product cause security as well as confusion. It provides a safety net via guarantee of money-back. Yet, it at a far higher price than normal insurance. The big question that we need to answer is, is that extra cost a good value as an investment or a gimmick.

This guide will explain it all. We’ll examine how these policies work, compare their costs and the advantages and disadvantages. By the end, you will have a clear answer to whether or not Return of Premium Life Insurance is the right one for your strategies concerning your finances.

What Exactly is Return of Premium Life Insurance?

Let’s start with the basics. Return of Premium Life Insurance is a special type of term life insurance. A standard term policy goes on to provide a death benefit to your beneficiaries if you pass away for a set time period (the “term”) usually 10, 20 or 30 years. If you outlive the term you forfeit some money on a policy, which expires, and you’ll get nothing back on the money.

This is where the “Return of Premium” (ROP) feature comes in.

It’s an extra piece which is often referred to as a rider to a term life policy. With this feature, should you live to be worse than the term of the policy, the insurance company refunds all of the base premiums you paid. This refund is normally paid to you as one lump sum and will be tax free. It’s made for people who want a life insurance plan for protection, but hate the idea of their premiums “disappearing” if they don’t use the policy.

Essentially, you have two potential positive outcomes:

1. You get a death benefit if you pass away.
2. You get your money back all in the event that you live.

This “have your cake and eat it too” method is the basic appeal of Return of Premium Life Insurance.

How Does ROP Life Insurance Work? A Step-by-Step Breakdown

Understanding the mechanics of ROP life insurance is not complicated at all. It has a distinct pathway from the moment of purchase till payout. Try to consider it as a regular term policy with a special condition at the end.

Here’s how it unfolds:

1. You Choose Your Policy: Just like an individual term life plan, you decide on your desired coverage amount (e.g. $500,000) and your desired term (e.g. 30 years). Your choices should be determined by a careful calculation of your family’s insurance coverage needs.
2. You Add the ROP Rider: You choose to add the “Return of Premium” feature to your insurance policy. This will immediately cause the premium to be higher than with a standard term policy with the same coverage and the same term.
3. You Pay Your Premiums: You pay the elevated premiums all through the whole term. This is critical. Missing payments or canceling the policy could void the money-back guarantee.
4. You Reach the End of the Term: After 20 or 30 years one of two things will have come about.

• Scenario A: You Pass Away During the Term. Your beneficiaries file a claim and are paid the full and tax-free death benefit. The policy has more than served its primary purpose. Additional money for the ROP feature is not refunded.
• Scenario B: You Outlive the Term. The policy expires. Within a few weeks or months, the insurance company sends you a check for all your base premiums that were paid over the decades.

This very simple process makes it an attractive option. However, the most important is in the premium cost, which we will discuss next. It’s a very important factor in considering this kind of coverage, especially if you are suffering from pre-existing health conditions that may increase your costs even further.

The Pros and Cons of Return of Premium Life Insurance

No financial product is right for everybody. A Return of Premium Life Insurance policy has certain advantages as well as quite serious disadvantages. Weighing them against your own financial situation is the only way you’re going to be able to make an informed decision.

The Upside: Why People Choose ROP Insurance

The benefits of an ROP policy are focused in the areas of security and psychological comfort.

• A Guaranteed Money-Back Feature: This is number one selling feature. You are sure to get something out of the policy. Either your family gets a huge amount of death benefit or you get all your premiums back. For many, this eliminates the sensation of “wasting” money on insurance.
• Forced and Disciplined Savings: Many people have the best intentions to save and invest but have a problem with discipline. An ROP policy implemented is a forced savings mechanism. The higher premium forces you to put some money away which you get back for sure.
• A Tax-Free Return: The IRS cannot count the returned premiums as income; it is considered a refund. This means that you won’t have to owe any taxes on the lump sum that is to be paid at the end of the term. A $15,000 refund is a true $15,000 donation into your pocket.
• Total Peace of Mind: Dual benefits structure provides total peace of mind. You know that your family is protected in a worst-case scenario and you know that you don’t lose your investment if you live out a long, healthy life.

The Downside: Potential Drawbacks to Consider

The downsides are largely purely financial and opportunity costs.

• Significantly Higher Premiums: This is the most significant hurdle. A term life with return of premium can cost 30% to 50%, or even more than a regular term life. This additional cash can be used for other money objectives.
• Major Opportunity Cost: Financial bigguns always like to offer the argument that you could “buy term and invest the difference.” Instead of paying for an advanced-pay policy or a premium one, you would be able to purchase a less expensive type (base ordinary) and invest your savings. Over 20-30 years that invested money could increase to be worth far more than the returned premium.
• Inflation Erodes Value: Regarding what you receive in 30 years, the money you receive will have less purchasing power than that of today. A refund of $20,000 today may sound bright, but it will be worth a lot less in the future because of inflation. Your “return” is in effect 0% interest.
• Lack of Flexibility: In order to receive your money back, you need to hold the policy throughout the term, and make no payments. If your life changes and you need to cancel, you will often lose all the additional premiums you paid to them. Unlike some forms of permanent insurance, there’s no cash value to mine. This makes it a less flexible option as compared to the debate on term vs whole life insurance.

Let’s Run the Numbers: A Cost Comparison

Words are one thing but numbers tell the real story. Let’s take a hypothetical scenario where we can see how a Return of Premium Life Insurance policy fares compared to a standard term policy and the “invest the difference” approach.

Scenario:

• Applicant: A healthy adult, non-smoking age 35 years.
• Policy: $500,000 in coverage for a 30-year term.

Here’s a table with comparisons with estimated monthly premiums.

At first glance the Return of Premium Life Insurance appears to be a clear winner. A net cost of $0 is hard to beat.

But what about the opportunity cost?

This is the very crucial next step in the analysis. The difference in the monthly premiums is $70 ($110 – $40). What if our 35yr old purchased the standard term policy and invested that $70 difference every month for 30yrs.

• Amount Invested: $70 per month.
• Investment Period: 30 years (360 months).
• Assumed Annual Return: Assumed annual return of 7% (average over-diversified stock market index fund will get around 7% growth).

Using a compound interest calculator that would mean $70 per month would increase by about $85,000 in 30 years.

The Final Comparison:

• ROP Strategy: You get back $39,600.
• “Invest the Difference” Strategy: You may be able to have $85,000.

And that’s after deducted the cost of the standard terms insurance, which is $14,400, the investment strategy leaves you with more than $70,000. This is considerably more than the ROP refund. This math is a big reason why many financial advisors turn clients off from Return of Premium Life Insurance.

Is ROP Insurance Worth It for You? Key Factors to Decide

So, seeing the numbers are there ever a case for ROP. The answer is yes but only for the right kind of person. The question “is ROP insurance worth it?” depends entirely on your behaviour and financial personality.

ROP Might Be a Good Fit If…

You may consider a Return of Premium Life Insurance life insurance policy if you share these following characteristics:

• You Are Risk-Averse and Value Guarantees: Whenever you think of a rising and falling stock market, the guaranteed refund by an ROP policy can be very attractive. You Know Offering You What You intend.
• You Lack a Strong Savings Discipline: To be honest with yourself. If you know that the “extra” $70 per month would likely be spent on coffee and subscriptions rather than investable, then the ROP policy forms the equivalent of a forced savings account. For you getting $39,600 back is better than having nothing saved. That’s a good strategy for millennials who need to start saving early.
• You’ve Already Maxed Out Other Investments: If you are already putting up the maximum for your 401(k), Roth IRA, and other tax-advantaged accounts, an ROP policy could be viewed as a non-correlated, risk-free place to park more funds.
• You Psychologically Hate “Losing” Money: To some people, the thought of paying for insurance and not receiving anything is a huge mental block. If joining an ROP policy is the only way that you’ll feel good about purchasing the life insurance your family needs, then it’s a small price to pay for that peace of mind.

You Should Probably Skip ROP If…

On the other hand, if there are any of the following descriptions of you, you should almost certainly avoid ROP life insurance:

• You Are on a Tight Budget: If the higher premium would take a toll on your monthly budget then do not buy it. Your top priority should be getting proper coverage for the lowest price. A standard term policy is the obvious winner here.
• You Are a Disciplined Investor: If you have the discipline to automate your investments, the “buy term and invest the difference” strategy will almost always result in a better financial outcome.
• You Need Financial Flexibility: 30 years is a long time to make a commitment. So, if you suspect that you may have to move, change careers, or access your money, an ROP policy is too rigid. Canceling it early means you lose the benefit (ROP); all the extra money you paid on it. So for flexible planning you’d consider family health insurance plans because they are often more flexible in set up.

Alternatives to Return of Premium Life Insurance

If you’ve concluded an ROP policy is just not for you, there are some fantastic alternatives to securing your family’s wellbeing and increasing your wealth.

1. Buy Term and Invest the Difference (BTID)

This is what we have outlined above as strategy. It’s the most popular recommendation of financial planners.

• Action: To buy a standard low cost term life policy.
• Action: Setup an automatic monthly transfer of the premium amount excess into a low-cost index fund or ETF.
• Benefit: You achieve a protection plus a potential for market growth and thus have much more financial power in the longer run. For further discussion on this popular strategy, Investopedia offers a detailed guide.

2. Standard Term Life Insurance

This is life insurance at its simplest and cheapest, too.

• Action: Purchase the coverage you need for your family at the lowest cost possible.
• Benefit: Maximum protection for Minimum expense. This then frees up the most cash flow to meet all your other financial goals, from paying down debt to saving for retirement.

3. Permanent Life Insurance (Whole Life or Universal Life)

If keeping you covered for life and building on a tax deferred cash value is your intent, a permanent policy may be a good option.

• Action: Research policies (whole life or universal life).
• Benefit: They have a death benefit that never expires and either a savings component (cash value) which grows over time. You may borrow against this cash value.
• Caveat: These are even costlier policies, than term life with return of premium. They are complex products that are most appropriate for high net worth people with specific estate planning needs. You can find out more information more directly about different life insurance types at the National Association of Insurance Commissioners (NAIC).

How to Find the Best ROP Life Insurance Policy

If you’ve done your research about Renewable Life Insurance and determined that a Return of Premium Life Insurance policy fits your individual circumstances, your next task is to shop for the best policy. Don’t just buy the first that you see.

• Shop Around: Prices for the exact same coverage: Between insurers prices can vary dramatically. Get quotes from a minimum of three to five different companies. An independent insurance broker here can be a great asset to you because they can pull out some quotes for you from across the market.
• Check Financial Strength: You are making a 20 or 30 year commitment to this company. You need to be certain that it will be around to pay the death benefits or reimburse you for your premiums. Check out the company’s financial strength ratings from independent companies such as A.M. Best. Look for companies that are “A” rated or higher. A company’s claim paying unit proves to an essential thing in a circumstance, just like you would want to find the best insurers with a high claim settlement ratio.
• Read the Fine Print: Understand ROP rider exact terms. So, what happens if you are late on a payment. Is the ROP benefit voided. Are rider costs included in the refund as well or only the base premium. Know what you are to sign before you sign.
• Consider Other Riders: Life insurance policies are customizable. You may wish to know the various riders available in life insurance plans so that you can include riders for any situation you may come across such as a waiver of premium (in case you become disabled) or a critical illness rider.

Frequently Asked Questions (FAQ) about Return of Premium Life Insurance

Here are the answers some of the common questions I hear from clients.

Conclusion: Is the Price of a Refund Worth It?

The concept of Return of Premium Life Insurance is very attractive. It taps into our natural tendency not to lose money and to get something back for our money which is a sadist’s delight. It offers essential protection to your loved ones while the promise of a full refund if you don’t use it is a seemingly perfect win-win situation.

However, this guarantee comes at a great price. The much higher premiums constitute a major opportunity cost. For the disciplined investor, who believes in the “buy term and invest the difference” strategy, is almost always the way to accumulate more wealth. The choice, therefore, is not so much numbers as it is human behavior.

This kind of policy is a niche product and designed for one particular mindset: the risk averse person who has difficulty saving on a regular basis. For them, a Return of Premium Life Insurance policy can be a useful investment tool, both for protection and force savings and for better than no savings at all. It’s sort of a structured solution that provides a different type of value than you’d get from group health insurance vs an individual policy.

Before taking any decision, please look at your own financial habits, budget status, and long-term goals and make an honest evaluation. If you are a disciplined and budget-conscious person then a standard term policy is your most efficient option. But, if you appreciate guarantees over prospective growth and know that you aren’t going to invest the savings, then the Return of Premium Life Insurance policy might just be worth the extra cost for you.