Traditional term life insurance policies range from 10 to 30 years in length. It’s designed to protect you temporarily and is often purchased by parents who want to make sure they are leaving enough money behind to support their children if they should pass before their children are self-sufficient adults.
If the policy holder outlives the term of the life insurance, they receive nothing for the money spent paying for the policy. Life insurance is a policy that you really don’t want to have to use, but for many people, the idea of spending money for 10 to 30 years on something you (hopefully) never use is a bad thing. If you like the idea of having insurance but hate the idea of “wasting” the money in the case that you don’t pass away during the term of your policy, you might want to look at return of premium life insurance policies.
Return of premium life insurance pays you back
If you take out a return of premium life insurance (ROP) policy and live longer than the expiration date of the policy, you get back 100% of the amount you paid. If you decide to cancel your policy before the pre-determined term is reached, you will only receive a small percentage of the money you paid back. Therefore, if you are considering a return of premium life insurance policy, you need to prepare to keep the policy for the full term.
If you pass away during your term, the return of premium life insurance policy provides a cash benefit to your beneficiaries just like a traditional term life policy will. On the other hand, if you should outlive the policy, which is what everyone hopes when they purchase the policy, you get back the thousands of dollars you spent on the insurance policy over the years.
Return of Premium life insurance policies are much more expensive than a traditional term life policy, often as much as three or four times the amount the same policyholder would pay for traditional term life. The higher costs are how the insurance companies are able to offer ROP policies. The insurance company invests the extra money paid in order to earn a return on the money that is used to refund the policies to people who outlive their ROP.
The money ROP policyholders receive at the end of their insurance term is not subject to income taxes, since it is just a refund of money you already paid. You do not earn dividends or interest on the money, which is why many investors believe you would be better off saving or investing the amount of money you pay toward the Return of Premium life insurance policy into mutual funds. Those provide a potentially higher return on your investment, although it is not a guaranteed return like the ROP. For people who pass away before the money has earned a return, however, there is no guaranteed cash benefit from a savings account or investment like there is with a return of premium life insurance policy.
Who should not get return of premium life insurance policies
While you are guaranteed either a death benefit or the money you spend back with ROP policies, it doesn’t mean a return of premium life insurance policy is the ideal solution for everyone. For example, if you have substantial amounts of high interest credit card debt, you are probably going to be better off choosing a less expensive traditional life insurance policy and putting the difference in premium expenses toward your credit card debt.
Return of premium life insurance policies may not be the best use of money for individuals with high income and substantial investments, either, since the money paid toward the ROP will not earn any return. If there is enough money to cover your death expenses and care for the people you leave behind when you pass away, a ROP may not benefit you much at all. People who can afford to increase their investments and obtain higher rates of return will end up with more money at the end of the term than they get back with a return of premium life insurance policy.
Debbie is a writer who specializes in parental finances, consumer spending and mortgages.