Pros and Cons of Return of Premium Life Insurance
Pros of ROP life insurance
The most obvious pro of a return of premium feature is the refund of the premium. Life insurance is important, but it can feel good to get that money back if you end up not needing the policy. The fact that you can essentially get a refund is also great for people who want protection but have a low risk tolerance. We often think of life insurance as a "what if" need – "What if I die and am not around to support my family?" – but some people might think of it as "What if I put $10,000 into a life insurance policy that I don’t use, and then I don’t have that money for my retirement savings?" With a return of premium policy, you don’t have to make that choice anymore. And as mentioned, since the return is considered a refund and not a payment, it's not taxable. You can also view a return of premium policy as a forced savings vehicle. If you aren’t great with money and want to make sure you have something saved up later in life, an ROP term life insurance policy provides you protection for 20 or 30 years, and at the end of it you’re rewarded with the money you put into the policy. That feeds back into the risk aversion aspect: instead of playing the stock market, you get a guaranteed amount of money back down the line. If you’ve heard this forced savings idea before when it comes to life insurance, that’s because it’s similar to the logic behind whole life insurance (and some ROP policies even have a cash-value component, which we’ll get into a bit more later). Generally, whole life insurance policies aren't worth the cost for most people who just need pure life insurance. But since ROP policies are relatively less expensive, it can work as a forced savings vehicle at a lower cost than whole life insurance policies for people who aren't disciplined enough or comfortable with investing on their own.
Cons of ROP life insurance
First, as mentioned, return of premium policies are more expensive than a basic term life insurance policy. That means you could be busting your life insurance budget by opting for a return of premium, and you might be better off doing something different with that money. But let’s get into the forced savings aspect again. When talking about the difference between term life insurance (where the policy ends after a set amount of time) and whole life insurance (which lasts for as long as you pay premiums, but is more expensive) there’s a common piece of advice that you should "buy term and invest the difference." The logic goes that the main selling point of whole life insurance – that you get an insurance policy along with a cash-value component that acts as forced savings – is actually a poor decision, and you’d be better off buying a cheaper term life insurance policy and investing the money you save elsewhere with a better return and lower fees. The same could be said about a return of premium policy. Rather than pay extra for the feature – again, around 30% more than with a standard policy – you could invest the difference and rather than get a guaranteed return with no upside, you can get a return thanks to a few decades’ worth of compound interest through something like an IRA or an investment platform like Betterment or Wealthfront. Even if some policies have a cash-value component, you run into the same problem as other cash-value policies like whole life insurance, where you may end up with a sub-optimal investment option. But this isn’t an apples-to-apples comparison, since whole life insurance is usually significantly more expensive than term life insurance, whereas a return of premium policy is usually only slightly more expensive than a basic term policy (depending on your age and profile). And the refund of premium at the end of the term, net-net, could be worth it if you have high risk aversion and are a value-seeker. Finally, you may be limited to the return of premium policies that are available to you. Certain insurers might only offer specific term lengths or minimum coverage amounts. This might not matter to you if the policies offered fit your needs, and you may find more flexibility with a return of premium rider that you can add to a wider variety of policies, but it’s something to keep in mind when you’re looking at policies that are available to you.
What alternatives are there to return of premium life insurance?
- Standard term life insurance. Most people only need a basic term life insurance policy. It's more affordable than a policy with return of premium features, and simplifies your finances because you don't have to plan for a large sum of money to be refunded to you later in life.
- Whole life insurance. A type of permanent life insurance, whole life lasts for as long as you pay your premiums and doesn't expire like term insurance. It also has an investment-like cash value that can increase over time. However, returns are typically not as good as a traditional investment, and it can actually lose value in some cases. Plus, whole life insurance is much more expensive than a term (or even return of premium) policy; as with ROP policies, it works in certain situations but may not be worth the cost for most people.
Is return of premium life insurance worth it?
Whether or not a return of premium life insurance policy is worth it depends on your individual financial situation and goals. Receiving a sizable chunk of money when you’re at or nearing retirement is nice, especially if you don’t have to pay taxes on it. But you have to consider you’re really just getting back money you already put in. It’s not extra money; it’s money that was already yours. It's also money that's lost out on years of compound interest, so it's worth less than it would have been if it was invested. Getting a premium refund tax-free is enticing. After all, a lot of our financial decisions revolve around lessening our tax burden. But you shouldn’t let that blind you to the flip side of a return of premium policy. You have to take into account not just the tax implications, but the upfront cost (higher premiums) and opportunity costs (missing out on better investment vehicles) that come with them. A return of premium life insurance policy can work for someone who can afford paying a little extra each month and wants a relatively low cost forced savings vehicle, but may not be right for someone who just needs a basic term life insurance policy to protect their family and is more budget-sensitive.