Return of Premium Life Insurance: Defintion, Advantages and Disadvantages

Return of premium life insurance, or ROP life insurance, is a special type of term life insurance. With traditional term life insurance, you pay a monthly premium to get a specified amount of coverage for a set amount of time, such as 20 years old.

If you do not die during that term, the policy ends and the insurance company keeps the premiums. With a return of premium policy, you still get a specified amount of coverage for a set period of time, but if you outlive the policy you get all of your money back.

For example, say you bought a 20 year return of premium life insurance policy. Every month, it was going to cost you $150. If you are still alive at the end of the 20 year term, the insurance company would refund you all of your premiums paid into the policy which would equal $36,000 in this scenario.

The obvious advantage to a return of premium life insurance policy is that you get your money back if you are still alive at the end of your term. Additionally, this amount that you get back is not subject to taxes since it is a return of premiums that you have already paid taxes on.

When you buy a traditional term life insurance policy, you do not get your money back if you are alive at the end of your term. The hope is that you are still alive at the end of the term, but if you are, you never get to realize the value of a standard term policy.

This is where an ROP policy can be quite attractive for some individuals. You still get coverage for a set period of time like a standard term policy, but you are guaranteed to get some value out of the policy if you are still alive at the end of the term.

The first disadvantage of ROP life insurance is that it typically costs two to three times more than a standard term policy. Some insurance sales people will make the case that you should view a ROP policy as a savings account since you will get your money back.

While this is technically true, the extra dollars that you send to a ROP policy could be better utilized in other ways. Secondly, inflation can erode the value of the money that will be returned back to you. For example, say that you bought a 20 year ROP policy that was going to cost you $200 per month.

Assume that inflation hovers around 3% per year over the next 20 years. When you get your money back in 20 years, your dollars would have lost 3% of value each year. An ROP policy returns your original premiums, but it does not grow your premiums like permanent life insurance does.

Finally, not all insurers that offer life insurance offer a ROP policy. You will likely have to do some digging to find an insurer that offers this type of policy. If you prefer to have all of your insurance policies with one company, it is not guaranteed you will be able to purchase an ROP policy with your current insurer.

Like most questions in personal finance, the answer is that it depends. An ROP policy can be more attractive than a standard term policy since you get your money back. The hope when you purchase any sort of term life insurance is that you will not need it.

If you buy a term policy, you guarantee that the only benefit you will get from it is the death benefit if you pass away. By purchasing an ROP policy, you still get the death benefit guarantee if you die during the term, but you also get your money back if you don't die during the term.

However, the two primary concerns you should think through are the risk of inflation and the increased cost of an ROP policy. For example, say that you could buy a standard term policy for $100 per month or an ROP policy for $200 per month for the same amount of coverage.

Let's assume that each of these policies has a 20 year term. If you bought the ROP policy and were alive at the end of the term, you would get $48,000 back from your insurer. However, what would happen if you bought the term policy and invested the difference of $100.

Assume now that you buy the term policy and invest the difference of $100 in the stock market each month through a Roth IRA. Assume that you can get a return of 9% from the stock market during the 20 year term of your life insurance policy.

If you were still alive at the end of the 20 year term, the value of your investment would be $61,392 given the assumptions above. By doing this, you will protect your dollars from inflation and still have life insurance coverage through your standard term policy at a cheaper cost.

As mentioned before, not every life insurance provider offers an ROP policy so you may have to do some digging around to find one. Fortunately there are reputable insurance companies that do offer these policies. Some of these companies include State Farm, Mutual of Omaha, AAA, and John Hancock Life Insurance.

As previously mentioned, a term policy may be better than an ROP policy. The primary reason for this is that it is typically cheaper which allows you to invest the extra money that would have gone towards an ROP policy which can protect your money from inflation.

A term policy only provides you coverage for a certain period of time, such as 10, 20 or 30 years. It is often bought by individuals to get coverage for a time in which other people rely on them financially, such as having a young family.

Although a standard term policy may be better than a ROP policy for certain individuals, it is not necessarily the best life insurance for everyone. In all likelihood, the majority of people will not need to use their term life insurance policy which is why you should also consider a permanent life insurance policy.

As the name implies, permanent life insurance provides you with coverage for your entire life. Unlike a term or ROP policy that will only pay out a death benefit if you die during the specified term, permanent life insurance is guaranteed to pay out whenever you die as long as you keep the policy.

Permanent life insurance can be used as a way to pass wealth from one generation to the next and can be used as an estate planning tool depending upon the size of your estate. In addition to a guaranteed death benefit, permanent life insurance offers another benefit.

A popular type of permanent life insurance is called whole life insurance. In addition to the death benefit, this type of policy also offers what is called cash value. When you pay your monthly premium into a whole life insurance policy it goes into three buckets.

First, it goes towards covering the cost of your insurance (i.e. death benefit). Secondly, it goes towards the costs to administer the plan. Finally, it goes towards building cash value. This cash value is part of a whole life insurance policy.

This cash value earns a guaranteed rate of return from the insurance company. They will take your money and put it into their general investing account which is how your money earns interest. Throughout your life, you can use this cash value in a variety of ways.

You can borrow against your cash value, take withdrawals from it, and use it to pay for the cost of your insurance. The policy is designed in such a way in which you are able to use it while you are still alive. These are often referred to as living benefits.

Keep in mind that permanent life insurance is more expensive than term and ROP policies and that the cash value takes time to grow. Additionally, whole life insurance policies or other types of permanent life insurance are more complex so you need to fully understand the policy to ensure it is the right fit for you.

The point here is that you should explore all available life insurance options to find the policy that is right for you. Different types of policies are best for different types of people. For you this may be a standard term policy, an ROP policy, a permanent policy, or a combination of them.

The bottom line is that return of premium life insurance is a type of term life insurance in which the insurance company returns all of the premiums that you paid into the policy back to you if you are still alive at the end of the term.

For some individuals it makes sense to get an ROP policy. However, make sure to evaluate the advantages and disadvantages of an ROP policy before buying one as a term or permanent life insurance policy may be a better fit for you depending on your individual needs and goals.