Return of premium life insurance policies are available from many life insurance companies, but is a life insurance policy with the return of premium option a good idea? It depends on your attitudes on investing, your budget, your long-term goals, and your desire for liquidity (or not).
There is no “one-size-fits-all” return of premium life insurance plan. Return of premium life insurance plans cost more than standard life insurance plans. Many life insurance agents push these policies for that reason…because they make more money and commission on selling more expensive life insurance plans.
If a return of premium life insurance policy fits into your attitudes on investing, your budget, your long-term goals, then it may be a good fit for you and your family.
If you are worried about liquidity (having your money tied up), getting locked into a more expensive life insurance plan, sacrificing part or all your premiums if you change life insurance plans early, or the negative effects of inflation on your money within a return of premium policy, then it may not be a good fit for you and your family.
What is return of premium life insurance?
Return of premium (ROP) is a type of life insurance that returns the premiums paid for the life insurance coverage if the policyholder survives to the end of the policy term or a period stated in the life insurance policy.
How does return of premium life insurance work?
ROP guarantees your beneficiary will receive a death benefit should you die during the term life insurance policy. ROP also guarantees you will receive all or part of your premiums back should you still be alive at the end of the policy.
Many people feel they have “wasted” their life insurance premium dollars at the end of a life insurance policy. ROP policies are geared towards people who dislike paying premiums and never getting their money back.
What are the advantages of return of premium life insurance?
You get all (or part) of your money back at the end of the life insurance term.
What are the disadvantages of return of premium life insurance?
Return of premium life insurance is more expensive than other forms of term life insurance and can be over triple the cost of a standard term life insurance policy.
If you switch to another life insurance policy in the early part of your term policy (typically the first 5 years), you’ll get no returned premiums.
If you switch to another life insurance policy later in your term policy, you will only get a percentage of your premiums returned (as low as 1%).
If you get to the end of your life insurance contract, you may not get 100% of your premium payments back. Some insurance companies only offer 75% to 90% of premiums to be returned.
With a return of premium life insurance policy, you are locked into a more expensive life insurance policy for the next 20 to 30 years.
You lose money every year due to inflation. For $100,000 invested in a life insurance policy, at a 3% inflation rate, with a 20-year return of premium policy, your plan would be worth only about $55,000 (when adjusted for inflation 20 years from now).
Liquidity is sacrificed as you have locked yourself into a higher premium life insurance contract. You cannot use this money to make other investments or pay down your mortgage debt during this time.
How is return of premium life insurance most often “sold”?
Return of premium policies are often sold as mortgage protection policies. The homeowner is told, if they invest in a 20-year return of premium policy, they will get all their money back at 20 years, and this will be enough to pay off the remaining balance of their home mortgage loan.
20 YEAR RETURN OF PREMIUM EXAMPLE The rate for a 40-year-old male with a $150,000 mortgage and a standard 20-year policy would be $51.53 a month with this company.
The 20-year return of premium option on this policy would cost $193.96 per month for the same 40-year-old male with a $150,000 mortgage. This is a difference of $142.43 per month.
The $51.53 monthly premium after 20 years totals $12,367.20 in paid premiums.
The $193.96 monthly premium after 20 years would total $46,550.40 in paid premiums. The return of premium policy cost $142.43 more a month than the non-return of premium policy.
The difference between the $51.53 in the $193.96 over the 20-year term is $34,183.20.
If you had taken out a return of premium policy in 1997 and it paid out in 2017, you would receive up to $34,183.20. But since your premium payment only returns premium, and has no provision to adjust for inflation, your $34,183.20 invested would now only be worth $22,733.53…you lost money due to inflation (as determined by the consumer price index (CPI).
Here’s something else to be cautious of – some companies only return 75% of your premiums paid into your policy. So, instead of receiving $34,183.20, you would only receive $25,637.40 after 20 years. After factoring in the consumer price index (CPI), your purchasing dollar will have been reduced to $17,050.14 in current year dollars.
You invested $34,183.20 to get back $22,733.53 or $17,050.14, respectively.
If you had invested $142.43 and received 6% interest over 20 years, your investment fund would be valued at $65,808.48. If you are in a 25% tax bracket, your $142.43 after taxes would be worth at least $49,356.36.
If you had invested your $142.43 into a different life insurance product, you would have access to your money without paying taxes, still have a death benefit, and this death benefit would not end at 20 years (it could last your entire life).
Return of premium policies for mortgage protection
Let’s look at what that life insurance salesman told you about paying off your home with the return of premium life insurance proceeds after 20 years.
With a $150,000 mortgage for 30 years at a 5% interest rate, your mortgage balance at 20 years would be $75,919.63.
You will still have a balance of $74,080.37 remaining on your 30-year mortgage at the 20-year mark.
With your ROP life insurance plan, you invested $34,183.20 to get back $22,733.53 or $17,050.14, respectively, in return of premium life insurance. Although this will help pay down your mortgage, it will not come close to paying off your mortgage.
If you had invested $142.43 and received 6% interest over 20 years, your after-tax gain would be $49,356.36. This would leave you with a $26,563.27 mortgage balance after 20 years.
More importantly, you would have maintained liquidity the entire time you held your life insurance and mortgage if you had invested money on your own, rather than letting the life insurance company control the use of your money.
But wait, the numbers can get worse!
If you are healthy and went to a different insurance company, your life insurance rates would be even better. If you are in great health, a 40-year old male could qualify for a $150,000 20-year term life insurance policy for $28.04 a month.
Are you seeing why that mortgage protection life insurance agent wanted to sell you a return of premium life insurance policy? At $28.04 a month, he would get a commission on a $336.48 annual life insurance premium. At a $193.96 ROP monthly premium, your life insurance agent got the commission on $2,327.16.
You lose money to inflation or reduced paybacks by the insurance company. You also lost liquidity because you do not have access to this money should any changes in life occur (unemployment, illness, etc.).
If you want to invest extra money in a life insurance policy, there are better life insurance plans for doing this that allow you to build cash value within the policy, access your money, guarantee you will never lose money, and provide tax-free access to your money within your plan for retirement or other financial obligations.
So, should I purchase return of premium life insurance?
It depends on your financial risk tolerance and budget. Some people like the guarantees that life insurance provides and are not worried about inflation and don’t want to worry about investing.
Many people view the return of premium policies as “forced savings accounts”, regardless of the future financial impact to their home and family.
If you are younger and want a 30-year return of premium policy, these policies are more affordable and the numbers to work out more in your favor. This is strictly, however, on a case-by-case basis. Call us so we can run the numbers for you to see if this makes sense for you.
Should I exchange or replace a return of premium life insurance policy?
We recommend caution when replacing any life insurance policy. Do not, under any circumstances, cancel a return of premium life insurance policy without having another life insurance policy in place.
Also, only deal with a life insurance agent you trust to be 100% honest with you. Many life insurance agents selling return of premium policies withhold facts that would otherwise negatively affect a life insurance shopper’s decision to purchase; stay away from these people.
At Life Wealth Win, we routinely replace policies sold to unsuspecting policyholders by other agents/agencies. These policies were not in their best interest, they weren’t explained, and they locked the life insurance shopper into a long-term contract they did not understand.
At Life Wealth Win, we will help you understand all your options, explain the financial impacts of your decisions, and help get you the best policy at the best price that best fits your unique situation.