Term life insurance provides a death benefit to your beneficiaries if you pass away during the term. But if you outlive the term, you have paid years worth of premiums and won't receive a benefit.
A return of premium life insurance policy allows policyholders to receive the amount they paid in premiums as a refund if they outlive the policy's term. This means the term life insurance will have a net cost of $0 for the policyholder.
Here's what you need to know about return of premium in life insurance.
What Is Return of Premium in Life Insurance?
With a return of premium (ROP) life insurance policy, if the policyholder is still alive at the end of the life insurance term, they will receive all of their premiums back as a refund. Since this is considered a return of principal, the return of premium is tax-free.
If the policyholder passes away during the term, the beneficiary will still receive the death benefit as they normally would with a typical term life insurance policy.
How Does a Return of Premium Policy Work?
Insurance shoppers can either buy an ROP policy as a standalone insurance product, or they can add ROP as a rider on a standard term life insurance policy.
Since the insurance company is taking on the financial risk of you outliving the term, the cost of return of premium in life insurance is much higher than that of a traditional term life insurance policy. You can expect premiums for an ROP policy to be two to three times the cost of a traditional term policy.
Benefits of ROP Policies
Though ROP policies are more expensive than traditional term life insurance, they are generally less expensive than whole life insurance policies. Whole life insurance guarantees a death benefit for your "whole life" rather than for a specific term, and it is the only traditional method of ensuring that your life insurance premiums are not "wasted." While your beneficiaries will not receive a death benefit if you live to a ripe old age with an ROP policy, you can feel confident that at least your premiums will come back to you.
Additionally, since the premiums are returned tax-free, this can be a decent method of forced savings. You will know that your loved ones are guaranteed to get a payout — either from the death benefit or from the return of premium — without having to deal with the risks of investing in the stock market.
Some policies will also allow you to convert your ROP term life policy into a whole life policy at the end of the term without a medical exam. This could be a savvy strategy to remain insured throughout your lifetime without having to pay whole life insurance premium costs the entire time.
Potential ROP Policy Pitfalls
While an ROP policy guarantees either a payout or a return of premiums, it is not necessarily the best choice for everyone.
The cost of ROP premium can be quite steep, and according to the Insurance Information Institute, some insurers may only refund the base premium for these policies. In other words, if your annual base premium for a traditional 20-year term life insurance policy is $350, and the ROP rider costs an additional $350, then you will only receive $7,000 back as a refund if your insurer only returns the base premium — even though you paid a total of $14,000 in premiums.
Don't forget that the buying power of your returned premiums will decrease over the length of the term due to inflation. This means investing the difference between a traditional term life premium and an ROP premium could have much better financial outcomes than simply handing it to the insurer to return at the end of the term.
Finally, depending on the policy, you may not be able to get your money back if you decide to cancel the insurance before the end of the term.
Is a Return of Premium in Life Insurance Right For You?
If you can afford the additional payments, want a guaranteed forced-savings vehicle, and want to keep the option of whole life insurance open in the future, then an ROP policy may be right for you. As with any policy, make sure you shop around among multiple insurers to find the right product at the right price for your needs.