Life insurance is a crucial financial tool that provides protection and peace of mind to individuals and their loved ones. Among the various types of life insurance policies available, one option that has gained popularity is the Return of Premium (ROP) Term Insurance.
ROP term insurance is marketed as offering a unique feature – the return of the premiums paid if the policyholder maintains the policy for the entire term of the policy. While this might sound appealing at first glance, it's important to consider the drawbacks that come with ROP term insurance before making a decision.
- Higher Premiums: One of the primary drawbacks of ROP term insurance is the significantly higher premiums compared to traditional term life insurance. The reason for the higher premiums is the promise of returning the premiums at the end of the policy term. While this may seem like a good deal, the reality is that you are essentially paying more for a feature that may not provide substantial financial benefits in the long run.
- Opportunity Cost: ROP term insurance locks you into a higher premium payment for the entire term of the policy, which could be 20, 25, or 30 years. The additional money you pay in premiums for the return of premiums feature could potentially be invested elsewhere for better returns. By opting for a lower-cost term life insurance policy and investing the difference in premium costs into other investment vehicles, you might achieve greater financial growth over time.
- Limited Investment Potential: Insurance companies invest the premiums they collect to generate profits. With ROP term insurance, the insurer is essentially using your higher premium payments as a form of interest-free loan. While they promise to return the premiums at the end of the term, the returns are often limited and may not keep up with inflation or the potential gains you could have earned by investing the money yourself.
- Complexity: ROP term insurance policies can be more complex than traditional term policies. Understanding the terms and conditions of the policy, including the exact circumstances under which you will receive the return of premiums, can be challenging. The fine print might reveal limitations and restrictions that could negate the perceived benefits of the policy.
- Long-Term Commitment: Committing to a ROP term insurance policy means staying with the same insurer for the entire term to benefit from the return of premiums. This lack of flexibility could be a drawback if your circumstances change or if you find more favorable insurance options in the future.
- Potential for Better Alternatives: Depending on your financial goals and needs, there might be better alternatives to ROP term insurance. For example, you could opt for a lower-cost term life insurance policy and simultaneously invest the difference in a diversified investment portfolio. This approach might provide better overall returns and more financial freedom.
- Refund Eligibility Conditions: ROP term insurance policies often come with strict eligibility conditions for the premium refund. Policyholders need to maintain the policy for its entire term and make all premium payments on time. If the policy lapses due to missed payments or other reasons, the refund might be forfeited. This can be a significant drawback for individuals who face unforeseen financial challenges and might struggle to keep up with premium payments.
Here’s a recent example I personally encountered.
- 35 Year Old Male, non-smoker, excellent health
- 20-year, $500K protection with Return of Premium at the end of the policy term
He was quoted $103.40/month and $110.49/month from 2 different carriers, both offering Return of Premium.
I recommended obtaining a quality 20-year Term policy and investing the premium difference in a mutual fund (ie, a non-qualified account or a Roth IRA account). I provided him 4 term insurance carriers, with premiums ranging from $26.90/month to $30.36/month (last one included Accelerated Living Benefits).
Let’s consider the potential differences:
$103.40/month (lowest priced ROP policy) Total paid over 20-years: $24,816
-$ 30.36/month (term with Accelerated Living Benefits) Total paid over 20-years: $ 7,286
$ 73.04/monthly savings
Then if you were to invest the difference in an account that averaged even an 8% average rate of return, at the end of the 20-years, you could potentially have ~$43,022 in your investment account. Assuming you kept the Return of Premium policy for the entire 20-years, here’s what you could potentially have:
$43,022 – Investment Account
$24,816 – Return of Premium
$18,206 – Net difference back in your pocket
Final Thoughts: While Return of Premium (ROP) Term Insurance might seem attractive due to the promise of receiving back your premiums at the end of the policy term, it's essential to consider the drawbacks and evaluate whether it aligns with your financial goals and priorities. The higher premiums, opportunity cost, limited investment potential, complexity, long-term commitment, and potential for better alternatives are all factors that should be carefully weighed before deciding on any insurance policy. Please note: Guarantees are backed by the claims-paying ability of the issuing life insurance company.
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2023.10.01 RegEd ID: 5983706.1