What Is A Return Of Premium (ROP) Life Insurance?

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Return Of Premium Life Insurance, as the name suggests, is a type of term life insurance policy coverage that will return your premiums paid back if you survive the term nominated in the policy you signed up for. For example, if you purchased a $500,000 policy for $5,000 a year over a 30 year term, this will result in you being refunded back $150,000 at the end of the 30 year period.

For the above reason, Return Of Premium Life Insurance costs significantly more than the traditional Term Life Insurance. According to my research, it can cost anywhere from 30% to 300% more. This is simply due to the fact that the insurance companies invest your premiums because they will have to pay you at the end of the nominated term. And bear in mind that the cash you pocket at the end is tax free as it is just a refund of your own invested money.

Now, let’s take a step back and look at the original concept of Life Insurance, more specifically Term Life Insurance. Term life insurance is a contract between an insurance company and an insured person which stipulates that in the event of the insured’s unexpected death, an amount of money will be paid to the beneficiary or beneficiaries as stated in the contract. When you sign up for a term life insurance, you will be paying monthly or yearly premiums to the insurance company over a predefined period of time. This is actually the most affordable way to acquire a substantial death benefit.

The biggest disadvantage of term life insurance is that when the predefined time period expires, you will have to renew your policy, very likely at higher premiums. Alternatively, you can convert your policy to a different plan or forfeit the total premium amount that you paid. You will agree that this is not a very attractive proposition. Therefore, to make this more appealing, insurance companies modified the original plan to provide additional benefits to customers.

One of the modification made to a term life insurance policy is for a return to the insured person the amount of premiums that they paid to the insurance company over the term of the insurance policy. This is what is nowadays called a Return Of Premium Life Insurance policy.

 

Advantages and disadvantages of Return Of Premium Life Insurance

 

The advantages and disadvantages of a return of premium life insurance policy vary depending on the:

  • Length of the contract
  • Amount of premium payable
  • Benefits stipulated in the contract

 

The advantages of return of premium life insurance include:

 

Flexibility

Just like any term life insurance, you have the flexibility to select the time period, the premiums and the benefits that best suit your needs.

 

Guaranteed premiums

Your premium payable won’t change throughout the duration of the coverage period you have selected, whether this is 20, 25 or 30 years.

 

Non-taxable return

As aforementioned the entire concept is a refund of the premiums paid. For those people that have an especially big estate, this is the most beneficial advantage as, with some effective planning, the investment return can be used to pay for taxes for the rest of their estate.

 

Guaranteed Return

Any regular non-banking type investment may promise high rates, but there is no guarantee. With a return of premium life insurance, the amount payable back to you is stipulated in the contract, therefore you are guaranteed to receive the premiums you paid as long as you live until the end of the contract period.

 

Financial Protection of Beneficiaries

In case of your untimely death during the policy coverage period, your beneficiaries will receive the death benefit either as a lump sum payment or regular payments.

 

In order to make a fully informed decision, here are some of the disadvantages of return of premium life insurance:

 

High premiums

Insurance companies are in the business of making a profit just like any other company. If you sign up for a return of premium life insurance policy, the insurer will end up returning your money: either to your beneficiaries on your death or at the end of the policy coverage period. Therefore, this type of insurance policy can cost significant more than a standard term life insurance policy.

 

Uninterruptible process

Once you have signed the contract, you have locked yourself in and cannot back out. Any cancellation will result in the full forfeiture of all the premiums paid to date. So, think twice before you put pen to paper; consider if your income flow is steady enough to cover the premiums payable for the entire duration of the contract.

 

Availability

Depending on the state you live in, the rules about life insurance may be different. For example, you may have certain restrictions placed on a return of premium life insurance or not even be able to sign up for one in some states. So, please check this carefully.

 

Return of Premium Life Insurance vs Traditional Term Life Insurance

 

We all know that ROP life insurance costs more than traditional life insurance. But how much more?  The bar chart below shows the costs difference between the two, based on coverage of $500,000 over 30 year term, for the age group of 30-50 year old.  In general, both man and woman pays more than double amount of costs for ROP life insurance than the traditional life insurance. However, if you hold the policy till the end of term, you will receive all premiums in one payment with no tax.  Therefore, you can treat ROP life insurance as a long term investment or saving for your retirement funds.

 

Return of premium life insurance vs Traditional term life insurance_BIR(Image source: yourlifesolution)

 

Is a Return Of Premium Life Insurance going to cover your needs?

 

You should consider various aspects before making a decision on signing up for a Return of Premium Life Insurance as it is such a long term investment. When seeking quotes online, you can simply do a Google search and type in “return of premium life insurance quotes” and compare the results to find the best policy.

 

If you have a steady and comfortable income and trying to plan ahead, then a return of premium life insurance is one of the best carefree insurance options available. Let me give you an example: say you are now in your mid-twenties and considering marriage – you may wish to consider a 20 or 25 year term ROP life insurance which will provide you with the necessary funds to pay for your first child’s university tuition fees in the future. Again, this is because the premiums you paid over the lifetime of the insurance policy will be returned to you at the termination of the insurance coverage period. And all this can be achieved without you drowning into financial stress.

Another example of where a ROP life insurance can become important is in the case of a divorce. There are some divorce courts that will decree that both spouse acquire life insurance, or that the spouse that is to pay alimony and / or child support, must purchase such a policy. This is in order to guarantee that the other spouse will be compensated for the alimony and / or child support loss.

For a better understanding of whether such an investment is actually warranted and will cover your needs effectively, you need to balance the premiums that you will be paying on a yearly basis versus the amount of cash that you will pocket out at the end of the insurance period. A small lump sum of money in 20 or 25 years may not be worth it as this may not cover your needs. A large sum of cash at the end of the insurance period is pretty attractive, however you will need to pay higher premiums for that, which may not necessarily be an option.

 

 

How do I calculate how much Return Of Premium Life Insurance coverage I need?

 

 

In order to determine the correct coverage amount for a return of premium insurance policy, you need to take into account the following:

  • Over the years, have you accumulated any unpaid debts that will draw a significant amount of your yearly income? For example, have you got credit cards or other loan debts that need to be repaid? If the answer is yes, then you need to make an allowance for these debts plus the associated interest.
  • Costs of sending your children to college. An average / reasonable amount would be $150,000 for a public college or $250,000 for a private college, per child.

 

  • Lost income: in the very unfortunate situation that you met with an untimely death and you need to address the needs of your beneficiary or beneficiaries assuming that you were the sole bread winner or simply that you had a large mortgage on your house that needed to be repaid. The easy and quick way to calculate an amount is to divide your current income in half and multiply it by the number of years that you want the return of premium life insurance contract to be valid for.

 

  • Funeral expenses. An amount of approximately $20,000 to $25,000 is adequate to cover funeral and burial expenses.

 

Adding the above four amounts will provide you with a close enough estimate of ROP life insurance coverage that will meet your requirements.

Now that you have determined how much insurance coverage will be best for your situation, the very next step is for you to find out the premiums payable for that coverage amount. This will vary across the various insurance providers, so please make sure you obtain a few quotes and compare the terms and conditions and read the fine print as well.

Now let’s look at an example whereby your main goal to take up a ROP life insurance is to cover the cost of your child education (in say 20 years’ time) at a private college which will be $250,000. Say you take up a $1,000,000 ROP policy, which costs you $15,000 annually for the next 20 years. At the end of the insurance policy, you would have paid $300,000 in premiums. Simply $15,000 x 20 years = $300,000. This amount of money will be available to cover your child’s private college. Therefore you can rest assured that your child’s future is in safe hands.

 

Combining options

 

If your income is not very high, your best bet would be the “buy term and invest the rest” concept. As aforementioned, a return of premium life insurance is a guaranteed money back investment which makes it carefree. However, as we have seen above, you are basically getting the premium you invested back and does not yield any extras. Considering this, you may wish to invest some of your money in a different scheme that will offer better returns.

As per the above example, let’s say you were to take an insurance coverage of $1,000,000 costing $15,000 annually; in 20 years’ time, you will receive $300,000. If the $15,000 annual investment is not a big stretch by any means, you may wish to consider an alternative option.

By reducing the coverage amount to say $500,000, you will only pay for a premium $7,500 per year instead of $15,000. This means that the guaranteed return will be $150,000 ($7500 x 20 years). In order to compensate for the remaining $500,000 of your original plan, you can invest $2,500 per year in a reputable investment fund, therefore saving you $5,000 per year. By “reputable” I mean an investment fund that has historically resulted in consistent profits margins for investors. Let’s assume that the average yield of this particular investment fund has been 10% over the years.

Investing $2,500 per year at an assumed average investment interest of 10%, your investment will have yielded $160,006 after compounding each year’s returns. Compounding means that interest is added to the principal amount. So, after the first year of investing $2,500 at a rate of 10%, your investment will grow to $2,750. At the end of the first year, you then take the $2,750 and add it to the next $2,500 that you intend to invest. So you will have invested a total of $2,750 + $2,500 = $5,250 at the start of the second year. You repeat this process for the next 20 years. Assuming all goes well and the average investment return is on average 10%, you will end up with $160,006 in 20 years’ time.

The total amounts in our example are:

  • $150,000 ($7,500 x 20 years) taken out of your pocket if you invested only in an ROP life insurance and $150,000 returned back.
  • $50,000 ($2,500 x 20 years) taken out of your pocket if you had chosen a combination, resulting in 160,006 in return.

 

The entire point of this exercise was that by combining options, you do not have to stretch your income to the limit. In fact, you saved $5,000 per year as follows: instead of investing $15,000 per year in a ROP Life Insurance, you invested only $7,500 and you invested another $2,500 in an investment fund. This makes up $10,000 worth of investment instead of $15,000 per year. Therefore, the amount of money you ended up saving or not forking out of your pocket was $100,000 (5,000 worth of savings per year x 20 years). Please bear in mind that the profit you made out of the investment fund is subject to taxes at your marginal tax rate. Depending on your circumstances, you may still end up in a much more profitable situation with a combination type investment.

Such a combination needs very careful planning and good advice from a trusted professional so that you end up making good investment decisions. It might also be advantageous to try and gather information on where insurance companies invest their money. Insurance companies always seek investments that provide good yields to have funds available for policy payouts. This means that they do not risk their money. It would be wise to use their knowledge and hit two birds with one stone.

You should now be in a ready position to make a very important decision in your life. Whether you opt for a Return of Premium Life Insurance by itself or you use it together with a combination in another investment fund is entirely up to you; please remember to be comfortable with the decision you are about to make.

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