Term insurance presents a big problem: Have a fixed term, and you get nothing if you pay a lot of money over the years. Getting paid requires your death. Talk about a lose-lose.
However, with return on premium (ROP) insurance, you can get your full refund at the end of the policy term – at a cost, of course.
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What is Return of Premium Insurance?
Return of premiums (ROP) allows you to get back every dollar you paid to the insurance company if you are still alive after the policy expires.
But let’s take a step back and talk about term insurance first. It is designed to cover your life expectancy in the event of your sudden death. This way, your spouse, children or relatives still have a way to earn money without your salary.
When you start the policy, especially for 20 or 30 years, your insurance company does not know if you will be there. The company is in danger. If you die, you’re on the hook for the amount of coverage in your policy. That’s why you pay wages.
Trying to get a refund on your life plan when it ends reminds me of a scene from the Disney comedy “Gone Fishin'” starring Joe Pesci and Danny Glover. A shrewd yachtsman closes the deal by telling the couple he can return the vessel within 30 days, no questions asked. The two friends happily destroy the boat in a series of complications and try to recover it – to no avail.
Similarly, with a life cycle of 20 years, well, you can’t go to your insurance company twenty years later and say, ‘Here I am. He’s still alive! How about you refund all the money I paid you since I don’t need insurance?’
With the return of primary insurance, however, that is what happens. Your insurance company takes all of your premiums over the years and puts them back into your bank account.
How Does Refund of Premium Insurance Work?
As you might expect, insurance companies will not give you this type of coverage for free. Simply taking an interest-free, multi-decade loan from you will not bring them enough profit to cover the repayments.
You will pay extra to have a chance to get your money back. In addition to living, you also need to maintain your policy and make payments throughout the period.
(It’s surprisingly easy to cancel term life insurance before the term expires. You simply stop paying your premiums and call or email your insurance company or fill out an online form to cancel your policy.)
Not all major insurance companies offer premium refunds. But ROP is sold in several ways. Sometimes they are independent (premium), or sold as a rider. Sometimes you can also get cash back as part of a permanent (perpetual) insurance policy such as whole life insurance.
If you die while your term insurance policy is in effect, the beneficiary will receive the payment as usual. But if you’re alive and your ROP plan is still in effect after it ends, you get back every cent (or almost every cent if there are fees) you paid.
Premium returns usually require a minimum of $100,000 in cash paid.
Average Cost of Return for Premium Life Insurance
I have already mentioned that return premium insurance is more expensive than term life insurance. But how expensive?
This depends on your health and age, among other things. But according to Policygeniusit is usually “two or three times more than the number of keywords.”
I used SmartAsset, which is Expedia’s equivalent of term insurance, to try to get a real quote on regular life vs. term life and return premium insurance.
SmartAsset’s search did not return a single company in its peer group that offers a 20-year ROP. The only company that offers a 30-year return on premium costs about six times the fixed rate.
Expect these points to be harder to find and more expensive to buy.
Premium Returns Pros & Cons
Here are some benefits of paying for primary insurance.
- Price availability: Most daily life plans end around retirement age. Now is a good time to find a good investment to increase your retirement savings.
- No tax: Unlike other income you get from businesses and retirement accounts, you won’t have to pay taxes on the money you get from your paychecks.
- Forced storage: There are some major drawbacks to using ROP as a backup method, which I will mention in the downsides. But it’s a way to lock in (possible) retirement income every month or year.
Here are some of the issues with returning premium insurance.
- Opportunity cost: Your most powerful tool when investing in retirement is time. Every dollar you invest decades after retirement can turn into more dollars by the time you’re ready to retire. Contributing money to an insurance company means you have less assets to invest in.
- Expensive: If you are in good health and young, you may be surprised to find that term life insurance is affordable, even with high benefits. When you add TOP insurance to the equation, this can change quickly. Also, if you die during this time, you will have paid more for the same price.
- A penalty is required: Will you be paying on time every month for 20 or 30 years? Do you think you don’t want to pay the monthly fee anymore at some point? If the answer is no, you may be violating the refund policy and lose everything.
- Negative feedback: Not only are you giving a free loan to the insurance company when you buy a ROP policy, you can lose money even if you get all your money back. Why? Over time, it is more likely that inflation will reduce the purchasing power of your original dollars.
Is ROP Insurance Necessary?
Like most financial products, you can do the math to see if the premium return is right for you. Investopedia it does a good job by providing a theoretical example.
Start by getting term insurance with and without ROP. Show the difference in total cost over the entire length of the process. Let’s say this number is $10,000 over 20 years.
According to Bankrate’s calculator, if you invest monthly and earn an average annual return of 5%, you will have $15,755. That’s about $6,000 more than if you returned your $10,000.
There are other factors to consider, including your family situation, risk tolerance, whether or not you are eligible to contribute to a Roth IRA, your income and your tax situation.
“The return on luxury life insurance is good for the right person,” says Clark. “It’s free insurance because they give you all your money back.
“If you’re just a regular person, you’ll start [a] process, you will keep it instead of 20 or 30 years. Many people can’t keep this tradition and it doesn’t work for them. But if you are, you get a free lunch.”
Personally, I would rather invest my extra money in a mortgage and hope to pay back the life insurance payout one day. Think about your life before you make a decision.
I’m a picky eater. It’s good to have choices in life.
Sometimes additional options do a lot of work before you make a decision to make sure you’re choosing the best option.
For long term insurance, the choice seems straightforward to me. Unless you find a plan that gives you ROP for a little exposure, the math is not clear.
You can find your own reasons for wanting to recoup the money – perhaps related to your risk tolerance or the feelings you’d face around “wasting” the money you spend on your policy if you had it. But there are no guarantees. And there are almost always ways to get a good return on your investment.