Choosing the best life insurance is no small task. Often, you're looking far into the future to try to figure out what your family would need in the event of your death. You've also got to balance that projected need with what makes sense now in terms of your health and finances.
One sore spot for many policyholders is that, with some plans, if you outlive your policy, you sacrifice all the money you poured in over the years. Enter what’s called “return of premium” life insurance. Read on to learn more about the pros and cons of this life insurance and whether it could be right for you.
What is return of premium life insurance?
As the name implies, return of premium (ROP) life insurance is a type of term life insurance policy with a unique feature: If you outlive the term of the policy, the premiums you've paid are returned to you. Unlike traditional term life insurance, where the premiums are typically not refunded if the insured outlives the term, return of premium life insurance can give you a financial safety net. Essentially, you're betting that your family will either benefit from the life insurance coverage in the event of your death or you will receive at least some of the money back if you live past the end of the term.
How does return of premium life insurance work?
Not every insurance company offers ROP insurance. Those that do either offer it as a specific policy or ROP rider that attaches to a term life policy.
Premium payment structure of ROP life insurance
The premium payment structure for ROP life insurance is similar to that of traditional term life insurance, but the premiums themselves are generally higher. This is because the insurance company takes on the additional financial responsibility of potentially refunding the money at the end of the policy term. Policyholders must pay their premiums on a regular basis, just like with a standard term life policy.
Accumulation of cash value over the policy term
Return of premium life insurance can build cash value during the policy period, and you can borrow against that value. If you live longer than the term, the insurance company returns the eligible portion of premiums you’ve paid, typically without interest.
Eligibility for a premium refund
Eligibility for receiving a premium refund is generally straightforward in an ROP life insurance policy. The primary requirement is that the policyholder lives longer than the term specified in the policy and has paid all due premiums. Failure to pay premiums could result in the policy lapsing, making you ineligible for the premium refund.
Note, however, that some companies don’t pay back 100% of your premiums – just a portion of them. If you sign up for a return of premium policy, make sure you read the fine print to know exactly how much money you can expect.
Conditions for receiving the premium refund
Receiving the premium refund isn’t necessarily automatic. First, the policy must be in effect at the end of the term, meaning you have made no claims and paid all of the premiums. Second, some insurance companies require a formal request to initiate the refund process.
Return of premium life insurance vs. traditional life insurance
The most significant difference between ROP and traditional term life insurance is the refund of premiums at the end of the policy term for ROP policies. However, this benefit comes at a cost. ROP life insurance premiums tend to be a lot higher than those for standard term life insurance policies. This can make ROP life insurance less accessible for some people, especially those who are more budget-conscious and are seeking the most affordable coverage.
Whole life insurance also tends to come with a pricier monthly premium than term life insurance, as it covers you until you die.
Consumers who decide that return of premium life insurance may not suit their budget or needs do have other options, including:
- Traditional term life insurance: This is often the most affordable choice, with lower premiums that never get refunded. Term lengths are flexible, often as short as five years. It works well for temporary coverage needs, such as providing coverage for large debts that would be difficult for your beneficiary to shoulder if you died early. Often, parents with young children will get term life insurance so they have coverage while their children are still dependents, but they don't necessarily want to extend it once the children have properly grown up.
- Whole life insurance: This offers lifelong permanent coverage and cash value savings that grow tax-deferred. You can borrow against that cash value or get it back if you cancel the policy. Premiums are fixed and usually higher than term life. It provides a death benefit plus savings that you can borrow against. However, flexibility is lower, and required premium payments continue for life.
- Universal life insurance: With universal life, the death benefit, premiums and cash value are typically all adjustable. This flexibility comes at the cost of higher premiums than term life. The cash accumulation earns interest, but returns are not guaranteed. It can supplement term life coverage while adding investment-linked cash value.
Considering your budget, investment risk tolerance, desired flexibility and the lifespan of coverage needed are key when weighing ROP versus these alternatives. Speaking with an independent insurance agent can provide guidance on pros, cons and aligning options with your specific insurance goals and financial priorities.
What type of insurance would be used for a return of premium?
ROP life insurance is a subtype of term life insurance. The primary structure remains the same: It offers coverage for a specific term, usually 20 or 30 years. Some agencies also offer ROP as a rider attached to a term life policy.
Return of premium life insurance advantages
People often buy term life insurance to protect their family during a policyholder's working years. A perk is knowing that some or all of those monthly premiums will come back to you if you live longer than the policy term.
Return of premiums if the policyholder outlives the term
This feature can give policyholders peace of mind, knowing that if they outlive the term, their financial investment will not be quote-unquote "wasted." It can be a risk-free way to ensure financial security, as you will either leave behind a death benefit or receive the premiums back.
However, it's important to remember that you won't earn interest on those payments. Therefore, while you'll get back what you paid, you might lose out on the potential gains you could have realized by investing that money elsewhere.
Savings component and cash accumulation
In addition to accumulating cash value, the return of premiums can act as a form of forced savings. For those who find it challenging to save money, paying into an ROP policy can serve as a way to set aside funds.
The tax benefits of ROP life insurance are similar to those of traditional term life insurance. Generally, the death benefit payout is tax-free to the beneficiaries. Additionally, the return of premiums at the end of the policy term is also usually not subject to taxation. This is because the IRS often views these returned premiums as a refund rather than income.
However, consulting a tax advisor for personalized advice is important, especially if you have complex financial circumstances. Different states also have varying tax laws that could impact your specific situation.
Return of premium life insurance disadvantages
The chance to recoup your policy premiums is a noteworthy draw, but that doesn't mean it will be the right choice for everybody.
Higher premiums compared to traditional life insurance
One of the most obvious downsides of ROP life insurance is the higher premium cost when compared to a traditional term life insurance policy. These higher premiums may make it less appealing for folks on a budget or those focused on finding affordable coverage. The additional cost can significantly more than what you'd pay for a traditional term life insurance policy, and for some, this extra expense might not justify the potential benefit of getting the premiums back at the end of the term.
You've got to assess whether you can comfortably afford these higher premiums over the policy's term. If stretching your budget to pay ROP premiums could compromise your financial stability or your ability to invest elsewhere, it might not be your best option. Plus, if you die during your policy term, you’ve effectively paid more for the same amount of coverage.
Limited investment growth potential
Though you'll get your premiums back if you outlive the policy term, they typically do not earn interest. When you consider the potential returns you could have earned by investing the difference in premiums between a traditional term life and an ROP policy, the opportunity cost is clear.
For those interested in an insurance product with an investment component, options like whole life insurance or universal life insurance might be more appropriate. These types of insurance policies are known for offering cash value accumulation that can grow over time, providing both a death benefit and a potential return on investment.
Not suitable for short-term insurance needs
ROP life insurance usually comes with long-term lengths, often 15, 20 or 30 years. This makes it less flexible and not necessarily well-suited for those seeking short-term coverage. If you're looking for a life insurance policy in connection with a short-term need, like covering a mortgage or protecting your family until your children are financially independent, then traditional term life insurance may be a more fitting choice.
Traditional term life policies often offer shorter terms, sometimes as brief as five or 10 years, providing more flexibility to match your specific needs. In contrast, the longer commitment required for most ROP policies won't align well with short-term objectives.
Is return of premium life insurance worth it?
The value of a return of premium life insurance policy ultimately depends on your individual circumstances and goals. If you're seeking the security of life insurance and the assurance that you can get your premiums refunded if you outlive the term, then an ROP policy might be a good fit. This type of insurance offers a kind of "money-back guarantee," which can comfort those averse to the idea of "wasting" money on premiums for a policy they may never use.
On the other hand, if your focus is on finding the most affordable coverage or looking for an insurance product with investment potential, more suitable options are available. To make an informed decision, consider your long-term financial objectives, risk tolerance and the basic aspects of life insurance that beginners should understand.
Which companies offer return of premium life insurance?
A number of insurance companies offer return of premium life insurance, each with its own set of terms and conditions. When shopping for an ROP policy, compare the premiums and other features like the policy term, eligibility criteria and other riders available. Some insurers offer additional perks, like the option to convert the ROP policy into a permanent life insurance policy without requiring a new medical exam.
The market for ROP policies is not as extensive as that for traditional term or whole life insurance. But as a starting point, you may want to look at offerings from State Farm Life Insurance, Mutual of Omaha and AAA.
Summary of Money's guide to return of premium life insurance
When comparing term life insurance with whole life insurance, you'll find a big difference in cost and coverage. Return of premium life insurance provides a middle ground between the two. On one hand, it offers the security of a death benefit while also providing the potential for a full refund of premiums if you outlive the policy term. On the other, the higher premiums, limited investment growth potential and long-term commitment make it less suitable for everyone.
By learning how ROP insurance works and asking an expert for guidance on your specific situation, you can determine whether return of premium life insurance aligns with your financial objectives.