Standard term life insurance policies come with non-refundable premiums. If you do not die within the policy term, all the money goes directly to the insurer. Return of premium life insurance is a term life insurance product, with which you get back the money you paid, if you outlive the term. It can be an appealing option if you are looking for a term life policy but do not like the possibility of never getting a payout.
Keep reading to find out what return of premium life insurance is and how it works.
What is Return of Premium Life Insurance?
Return of premium life insurance (also known as return of term life insurance) is term life insurance with a difference. Like a traditional term policy, it lasts for a specific period. However, unlike a traditional term policy, return of premium insurance refunds all of the premiums paid into the policy if the policyholder survives the policy term.
The payout is issued at the end of the policy term and is not subject to tax. Which is not surprising, though, since the insurer is just returning the payments, you made. And if you pass away during the term, a return of premium life policy will issue the death benefit to your beneficiaries just as a traditional term life plan would.
A return of premium life insurance plan is structured in one of the following two ways:
- You can buy a return of premium policy as a standalone financial product. That is, you will not need to add the rider separately
- You can buy a term life insurance policy and then add a return of premium rider
Regardless of how the policy is structured, one thing is for sure — the money-back feature can cost a pretty penny. You will have to pay significantly more than what you would pay for a base term policy.
How much more? The cost of return of premium rider depends on several factors, including your age, health classification, and choice of insurer. Generally speaking, return of premium insurance is two or three times the cost of a base term policy.
How Does Return of Premium Life Insurance Work?
You can add a return of premium rider to a traditional term life policy at the time of purchase. The money-back feature lasts for your policy term. Return of premium life insurance works in the following way:
- You make premium payments, monthly or annually, to maintain coverage. The insurer calculates your premium rates based on the policy amount, length of the term, age, health, and medical history.
- If you pass away during the term, the insurer will pay your beneficiaries a certain pre-defined amount, called the death benefit. A life insurance beneficiary is a person or people you name to receive the death benefit upon your death.
- If you survive the policy term, the insurer will refund all the money you paid into the policy without any interest. This income is not taxable, as you are simply receiving the payments you made.
However, you will pay a considerable amount extra for this money-back feature. While premium rates are unique to the applicant, research shows a return of premium life insurance policy can be two or three times costlier than a standard term life plan.
Pros and Cons of Return of Premiums
No financial product is perfect — and the same goes for the return of premium life insurance. It comes with its own set of benefits and drawbacks. Do the pros outweigh the cons? Life insurance needs are rarely one-size-fits-all. It will depend on your individual financial needs.
Pros of return of premium life insurance
Refunds premiums at the end of the term
If you survive the policy term, the insurer will refund all the premium dollars you paid. Furthermore, this income is not subject to tax.
Forces policyholders to save money
Let’s face it. Saving money is not easy. Many of us feel bad about spending too much, and yet we are unable to save enough. A forced savings vehicle can help break this cycle. You pay some money today and get more money back in a few years.
A return of premium policy is costlier than a traditional term life policy. But the upside is, if you survive the term, you will get back not only the extra money you paid for it but all of your premium dollars.
Costs less than whole life insurance
Return of premium life insurance is significantly cheaper than whole life insurance.
Cons of return of premium life insurance
Considerably expensive than term life insurance
The money-back offer does not come cheap. You are likely to pay two to three times the cost of a basic term life policy.
The insurer will not pay interest on your premium dollars
You will get back what you paid. So, in a sense, it is like a personal loan to your insurer. After a certain period, the provider returns your money without interest. However, because of inflation, the value of the money returned to you is depreciated.
Canceling the policy mid-term might mean no refund
Generally, if you cancel the policy before its terms, you will not get any of your money back.
Return of premium life insurance is not a great way to save
Traditional investment accounts are likely to offer you a much better return than a return of premium policy.
Is Return of Premium Worth it?
Traditional term life insurance does not guarantee a payout. The insurer pays only if you pass away during the term. If you outlive it, there is no payout. This arrangement may seem unfair to some. They may be put off by the idea of paying thousands of dollars of premiums over the life of a policy without any guarantee of a payout.
Return of premium life insurance can be a good option for these buyers, especially if the extra cost is not an issue. However, if you are looking for affordable term life insurance, it is not for you.
Tax-free premium refund is the main selling point of return of premium term life insurance. Receiving a substantial amount of money close to your retirement can be comforting, even more so when it is tax-free. But, when you think about it, you are not getting any extra money.
The insurer is simply returning what you paid. Furthermore, if you had put this money into a traditional saving or investment account, you would have probably ended up with much more.
Here is an example.
Mark, a 40-year-old non-smoker, will have to pay $145 a year for a 20-year term life policy with a death benefit of $100,000. However, if he buys a return-of-premium policy for the same term and amount, the cost will jump to $499 a year. That is an increase of $354 annually.
Without the rider, Mark will pay $2,900 over the life of the policy. Adding it will bring the cost to $5,988.
Is the refund of premiums worth paying an additional $3,088 over 20 years? Perhaps not. Mark is likely to get a better return from traditional savings or investment accounts.
Because of the high costs, return of premium life insurance might not be a great option for everyone. You may be better off using a standard term life policy to safeguard the financial security of your loved ones and investing in traditional investment accounts to save money for retirement.
A traditional term life policy pays out if you die within the term, not otherwise. By contrast, a return of premium life insurance policy pays in both scenarios. If you pass on while the policy is active, your beneficiaries will receive the policy amount. If you are alive at the end of the term, you will get a full refund of your premium. However, these policies are a lot costlier than traditional term life policies and as such might not work well for everyone.
Whether you are looking for a traditional term life insurance policy or a return of premium policy, you can count on Dundas Life to help you find the best deal. We work with all top Canadian insurers and specialize in helping customers find a life insurance product that perfectly matches both their budget and long-term financial goals.