Return of Premium Life Insurance: Pros & Cons



First, if you’re healthy, do you
even need a life insurance policy?

Everyone needs a life insurance policy.

Especially someone who is the main income earner in a household.

After all, in the event of your untimely death, burdening your loved ones with your debts, unpaid taxes, estate taxes, and funeral costs are simply unthinkable.

So what kind of life insurance is best for you?

It really depends on a multitude of factors.

For instance, how much can you afford to spend on life insurance premiums every month?

The rate you pay for premiums will depend on things such as your age, your health, your medical history and risk factors such as how dangerous your current profession is or how many car accidents you’ve been in.

In all instances, what you pay in premiums will depend on the length of the policy you payout and the amount you wish to have as a benefit in the event of your death. The shorter the term of the policy, and the lower the death benefit that would be paid out to your loved ones, the less you will pay every month.

Which kind of life insurance should you choose? Term vs Whole

Overall, there are two types of life insurance to choose from: whole life insurance and term life insurance.

Whole Life Insurance
Term Life Insurance

Whole life insurance covers the beneficiary for the duration of their entire life, provided the premiums are paid on time. A whole life policy also can earn savings through what is referred to as “cash value.”

Cash value is essentially an asset that increases in value the longer you hold onto the policy. You can tap into the cash value of a policy after several years if you are in need of emergency funds, or you may be able to use it to take a loan out against the policy.

The rules and restrictions for whole life insurance vary by the insurer.

On the other hand, term life insurance, like the name implies, provides coverage for the person for only a set amount of time – on average between 10 and 30 years. This coverage, understandably, is much less expensive than whole life insurance.

In term life insurance, as mentioned earlier, usually the shorter the time period, the lower the premium (depending on the beneficiary’s health).

The reason for this is that if an insurance policy term expires before the person dies, the insurance carrier will have taken premiums throughout the life of the policy and not have had to pay out any benefits.

In other words, the beneficiary will have paid out a monthly premium every month for 10, 20 even 30 years, and have nothing to show for it.

For many policyholders, this can be very frustrating.

Recent studies have shown that as many as 70% of term policies issued in the United States terminated before any benefits were paid out by the insurer. It’s little wonder how insurance companies continue to be profitable, even in down economies.

Having your life insurance term expire can leave you with nothing.
Is Return of Premium Insurance the answer?

There is a type of term life insurance that is growing in popularity: Return of Premium Life Insurance.

Return of premium life insurance is term life insurance that does exactly what the name says. If you outlive the policy, you get all the money you’ve paid out in premiums back. Every penny. What’s more, the money you get back is not taxed.

For many people, this is a far safer option than normal term life insurance, especially when the life of the policy is relatively short (5 or 10 years) because the beneficiary wanted to pay the lowest premiums possible.

What often happens, in this case, is the person outlives the policy, then has to buy another term policy that has far higher premiums due to their older age and/or new medical conditions that didn’t exist when they were younger.

However, there are several downsides to the return of premium life insurance.

Weighing the Pros and Cons of Return of Premium Life Insurance

First and foremost, the biggest downside is the cost.

If you choose a return of premium policy, it will cost you much more than a traditional term policy. Depending on the insurer, you could be paying 30% up to as much as 300% more in premiums.

Furthermore, the money you get back at the end of the term does not include any interest, nor is it adjusted for inflation.

When you consider that the policy could be for as much as 30 years, that is a long time to be paying into a fund that earns nothing.

It is obviously true that getting a large amount of money back in your bank account if you outlive your policy is better than getting nothing at all.

Pros and Cons of Return of Premium Life Insurance

That said, would you have been better off paying less each month in premiums and invested the difference?

After all, even investments that carry the lowest risk – such as opening a savings account or investing in certificates of deposit or money market accounts – still earn interest.

This is why you need to weigh whether or not a return of premium life insurance policy is best for you and your family.

Getting your premiums back vs playing the stock market

Some people simply do not trust the stock market or other investment vehicles. This is certainly understandable, especially if they were hit hard by the economic collapse of 10 years ago.

Over 60% of all US households saw a significant decline in wealth during the Great Recession, many of whom saw their retirement savings wiped out. This is not to mention the millions of Americans who lost their jobs, we’re unable to find work, and who accrued mountains of debt.

Others, for lack of a better way of putting it, simply do not trust themselves.

With investment accounts there is always the temptation to withdraw funds early, even with a penalty.

In this sense, a return of premium life insurance policy is almost like a forced retirement account. You can’t get the money back until the term ends.

Premiums Back vs Playing Stock Market

It is not an asset you can tap into before then. There is a certain piece of mind in knowing that either your family will receive benefits in the event of your death, or you will get a sizeable amount of money at the end of the policy term, usually when you are in retirement or very close to it.

This is not to suggest that a return of premium life insurance policy is or is not the best choice for you. What we are saying is that you carefully need to weigh the pros and cons with your adviser before deciding whether or not it is.

Again, monthly premiums for this type of policy is usually, at a minimum, 30% higher than traditional term life insurance. For many households, this is a significant expense, one that can adversely affect a family’s budget for things such as health care, utilities or even emergencies.

More importantly, with a ROP rider to your term life insurance policy, you are not investing that extra money you are paying in premiums – even if it feels like you are. Instead, you are doing the equivalent of putting the money under your mattress.

You may be protected from having the term of the policy end and having nothing to show for years of paying monthly premiums, but at the same time, none of that money you paid out-earned interest or was adjusted for inflation.

You simply get back the amount of money you put in. And the money you put under your mattress today will simply not be worth the same amount in 10, 20 or 30 years due to inflation.

To give an example, say you pay $100 a month in premiums (just to get a nice round number). Over the course of 20 years, you will have paid $24,000 in premiums over the life of the policy. So after 20 years, you’d get a check from your insurer for $24,000.

Historically, inflation rates in non-recession years tend to be between 2% and 3%. In 2018, for example, inflation rates fluctuated between 1.9% to as much as 2.9%. This is how much the dollar’s purchasing power diminishes over time.

Using inflation calculators such as those found on finds that $24,000 in 1999 would have the same purchasing power as $36,990.65 in 2019. In other words, you would need to spend nearly $37,000 to buy goods and services that would have cost $24,000 20 years ago.

Yet, on a return of life premium rider to your term policy, you would only get $24,000 back after those same 20 years.

Another way to look at is what your potential payout might be at the end of a life insurance policy, if you merely acquired term life insurance with a lower premium than a ROP rider, and invested the difference.

Assuming you have the discipline not to touch your investments during the penalty period, you can potentially earn significant returns with compound interest.

Compound interest is essentially the re-investment of interest instead of having it payout annually. According to NerdWallet, over a long time period, a diversified growth portfolio can return an average of 6% to 7% annually if left untouched.

So even though you may not get your premiums refunded to you should you outlive the term of your policy, you could still possibly get a sizeable amount of money without a ROP rider.

Depending on how your investment portfolio performed, the amount of assets you have at the end of the policy may be more than the amount paid in premiums over the same period.

This would be an important discussion to have with your financial advisor, to decide whether investing money long term would leave you with more money down the road than a return of life insurance policy, taking into account inflation, interest and taxes (remember, you pay no taxes on a ROP policy payout).

You should also carefully consider the short term consequences of the policy you take out, and whether or not you can really afford the higher premiums a ROP insurance rider demands.

Return of Premium Term Insurance vs Whole Life Insurance

As stated previously, for those especially worried about outliving a policy and having nothing to show for years of paying premiums, there are also whole life policies (also called cash value policies) if a ROP term policy is not right for you.

Return of Premium Term Insurance vs Whole Life Insurance

These policies cover the entire life of the beneficiary, no matter how long they live, so long as they keep paying their premiums. When you die, your family would receive the full death benefits tax-free.

Just as importantly, these policies also include a savings account, or “cash value” that earns interest every year.

This interest is a dividend from the life insurance company’s annual profits, similar to a stock. However, unlike the stock market, life insurance companies usually guarantee a certain amount of growth every year, guaranteeing a return.

Understandably, whole life policies tend to be especially popular immediately after economic downturns, when the stock market loses trillions in value.

How do you decide which life insurance is best for you?

It should be noted that not all insurers will give you the option of purchasing whole life insurance, ROP insurance or will offer a ROP rider onto a term life insurance policy.

You may want to look around and compare rates and policies, even from insurers that do not offer ROP insurance, to make sure you are getting the best terms and policy for you.

If you do decide to go with a ROP insurance policy, make sure you discuss with your agent what exactly you’ll be paying out in premiums over the course of the policy, and what exactly you can expect back if you outlive it.

Of course, before you make any investment or life insurance decisions, be sure to consult with a professional.

Which life insurance is best for you

We also are always happy to answer all your questions, and walk you through the entire process of attaining the right policy.

Give us a call today!

We’re here to help! Call us today.

Now It’s Your Turn

I hope You Understanding Pros & Cons: Return of Premium Life Insurance

And now I’d like to turn it over to you:
Did you learn something new from this

Or maybe you have a question.

Either way, leave a comment below right now.

Insurance Professionals of Arizona
IPA Team

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