As you already know, life insurance is a necessity, particularly if you have loved ones who depend on you financially. However, when looking for the right policy, you may assume that the only options are either term or whole life insurance. After all, those are the most common plans available, accounting for over 95 percent of the industry.
However, there is an alternative available called Return of Premium Term Life Insurance. Today, we want to discuss how this kind of policy works and whether it could be right for you and your family.
What is Return of Premium Life Insurance?
Fortunately, this kind of insurance is relatively easy to understand. In fact, it explains the basics of how it works right there in the name. Simply put, this is a term life insurance policy that returns your premiums to you if you outlive it.
In case you’re unfamiliar with term life insurance, here is a brief overview.
- First, you choose the amount of your death benefit. This is the amount of money paid to your beneficiaries (i.e., a spouse) if you die before the plan expires.
- Second, you choose a period for your policy. Term insurance can last for anywhere from one year to 30 years, depending on how long you want coverage.
- Finally, you need to name beneficiaries. Typically, a spouse or relative is the best option, as children under 18 can’t receive a death benefit before becoming a legal adult.
So, how does return of premium (ROP) term insurance differ? Everything else about the policy is identical, except you get back all of your premium payments at the end of the term. A better way of describing this plan is that it’s technically a rider (attachment) to standard term life insurance.
At first, it may seem like a no-brainer to add a ROP rider to your insurance policy. After all, it seems to provide the best of both worlds. If you die within the term, your loved ones receive the death benefit.
If you outlive the insurance, you get paid back. However, we need to delve a little deeper into the pros and cons of return of premium life insurance before you can make a final decision.
Advantages of Return of Premium Life Insurance
First and foremost, the primary reason to get a ROP rider is that you get all of your premium payments back. With a standard term policy, you could be insured for 20 years, but if you outlive the plan, all of that money is gone. If and when that occurs, it can sometimes feel like a waste of investment.
Let’s break down all of the advantages that can come with a return of premium life insurance policy.
Most people are not saving as much money as they should. If you’re struggling to keep funds in your accounts (particularly for retirement), then a ROP rider may be an ideal choice.
Rather than trying to save the money yourself, you’re asking the insurance company to do it for you. For some people, this kind of arrangement will work better than trying to handle it personally.
Guaranteed Death Benefit
While saving money for 10 to 30 years is a great way to invest in your future, a return of premium life insurance policy also provides peace of mind. If something were to happen to you during the term, your loved ones would still be protected financially. If you’re planning on getting a term life insurance plan already, it may be more prudent to add a ROP rider as well.
Let’s say that you pay $1,200 a year for your ROP policy for 20 years. By the end of the term, you will have amassed $24,000, a reasonably substantial windfall. Better yet, all of that money is issued tax-free. This is because the funds are not considered income, but a refund. No taxes is another reason why a ROP rider is similar to putting money away in a savings account.
Build Cash Value
In some cases, you may be able to amend your return of premium life insurance to build cash value during the life of the policy. Not all insurers have this option, so it’s imperative to compare plans before making a decision.
If you do get to build cash value, you can borrow against that during the term. However, you must repay all funds according to your loan statement, or you’ll incur penalty fees. Also, the funds will be taken out of the death benefit as well.
Disadvantages of Return of Premium Life Insurance
For many people, the advantages that come with a ROP rider seem too good to be true. However, there are a few considerable downsides that you need to understand before signing up. Here are the potential drawbacks of this kind of life insurance.
One problem that many people face with life insurance (of any type) is that they struggle to maintain payments. According to the Life Insurance Market Research Association (LIMRA), about one in 14 people lapse on insurance payments every year. Unfortunately, even a single missed payment could put your policy in danger.
So, knowing that you have to pay more for return of premium life insurance might force you to reconsider. Not only that but if you’re older (over 40), those increases could be much more significant. In some instances, you could pay twice as much as you would with a standard term life insurance plan.
That being said, if you can afford the higher payments, it helps to know that you’ll get all of that money back in the end anyway.
No Refund for Early Termination
With some insurers, you might be able to cancel your insurance before the term is up and get a reduced refund. However, even in those cases, you’ll likely face penalties, which means that you won’t get 100% of your money back.
In other situations, you may not receive a refund at all. If you’re worried about having to cancel a policy early, be sure to talk to your insurance agent about potential refund opportunities. Also, it may help to get a shorter term, so you don’t have to pay for as long.
While your funds don’t incur taxes at the end of your term, they don’t appreciate in value either. Even if you put the same amount of money away each year in a savings account, you would wind up with more money than you started. So, if you’re looking to use a return of premium life insurance policy for savings, it may be better to put those funds into a high-yield investment instead.
One potential option is to determine the difference in premium costs between a standard term life insurance plan and one with a return of premium rider. Then, take that difference and invest it, either in a retirement account (i.e., an IRA) or taxable investment account.
When to Get a Return of Premium Life Insurance Policy
Overall, knowing the pros and cons of return of premium life insurance can help you make the right decision for your situation and your loved ones. Here are a few instances where a ROP rider makes sense.
Short-Term Insurance Needs
Let’s say that you’re planning on getting standard term insurance for 10 years or less. Perhaps you just want to be covered while your children are in college, or maybe you need life insurance for a new business venture.
Regardless of the reason for getting short-term life insurance, it will probably be ideal to add a ROP rider to it. Since you will only make payments for a few years, the idea of getting that money back can seem really appealing.
If you struggle with saving money, then getting a ROP rider may be a smart decision for long-term planning. That being said, you need to make sure that you can afford the monthly premiums. If you’re already having a hard time paying your bills, you don’t want to invite the prospect of lapsing on your policy.
Also, if you are planning on using the return as a windfall, either as an emergency fund or for retirement, we highly recommend planning on it as extra income. You will still want to maintain high-yield retirement accounts so that most of your money is growing for the next 20 or 30 years.
When to Avoid a Return of Premium Life Insurance Policy
As we mentioned, there are some considerable benefits to having a ROP rider, but it comes with a few caveats. Here are the times when this kind of policy isn’t a good idea.
Old Age/Health Problems
If you’re already over 30 (and especially if you’re over 40), a return of premium life insurance plan may be prohibitively expensive. Also, if you have certain health problems (like obesity, diabetes, or heart disease), these costs will only continue to rise. Instead, it’s typically better to go with a standard term insurance plan so that your monthly payments are more manageable.
The other reason to avoid a ROP rider is if you’re not sure that you’ll outlive the policy. While it’s nice to assume that you’ll be around in 20 years, you want to be realistic. If you suffer from significant health problems, you don’t want to pay more for something you won’t get to profit from later on.
No matter how you look at it, return of premium life insurance is not ideal for investing your money. Instead, you want to put those funds into investments that will grow over time. This way, you can earn interest, and you’ll have substantially more money by the end of the term.
Not only that, but you don’t even have to be particularly aggressive with your investments. A savings account with a minimum yield (i.e., 1.8 percent) will still do better than a ROP policy.
Alternatives to Return of Premium Life Insurance
If you decide that ROP term insurance isn’t right for you, then it helps to know what other options are out there. As we mentioned at the beginning, the two most common varieties of life insurance are standard term life and whole life.
Standard Term Life Insurance – this option is best if you want to protect your loved ones for a specific period, like 20 years. This is also the cheapest form of life insurance, with low premium payments.
While these plans have various advantages and disadvantages, the best approach is to ask the following questions first:
- Why do you want life insurance?
- Who will receive the death benefit? How many beneficiaries will you have?
- How much life insurance do you need?
- Will you need insurance during retirement?
- Do you have any health problems or family history?
Overall, it’s much better to approach the process of buying life insurance by knowing what you want. This way, you can customize your plan to fit your needs, not the other way around.
No matter what kind of life insurance you want, you need to know all the options available. Feel free to reach out to us and we’ll discuss the different variables you need to understand. At NextGen Life Insurance, our goal is to provide you with the best coverage and peace of mind. See how we make life insurance easy.