What’s a Return of Premium Rider for Life Insurance?

Updated

One of the major reasons Amazon Prime is so popular is its liberal return policy. When you buy something through your Prime membership, you typically have at least 30 days to return it for a full refund of what you paid. Amazon will even pay the return shipping costs. 

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Wouldn’t it be nice if your car insurance worked the same way? It would be great to get a letter every year on your policy anniversary date from your auto insurer saying, “Great job driving this year. No accidents or speeding tickets. Here’s a check refunding all of the premiums you paid this year since we didn’t have to pay out a nickel to anyone. Keep up the great work!”

Sorry, that’s just a fantasy. But there really are some life insurance companies that will give you back all of the premiums you paid for a life insurance policy if you don’t die. Hard to believe, but it’s true. 

Let’s take a look at this little-known, little-promoted type of policy, its features, cost, pros and cons, and more. 

What Is a Return of Premium Rider for Life Insurance?

A return of premium (ROP) rider for a life insurance policy, which is also sold as a standalone policy by some insurers, refunds all of the premiums you’ve paid if you are still alive at the end of the policy period. 

If you die while the policy is still active, your beneficiaries will receive the death benefit, just as a standard term life insurance benefit.

How Do Return of Premium Riders for Life Insurance Work?

Return of premium riders are added to standard term life insurance policies. If you’ve ever purchased a term life policy before, you’re familiar with selecting a term length when you complete the application, such as 10, 20, or 30 years. 

With a return of premium rider, your beneficiaries will receive the death benefit listed in your policy if you die during the specified term. However, if you “outlive” the term, you’ll get back exactly what you paid in, but you won’t receive interest. The money isn’t considered taxable; it’s a refund of the payments you made to the life insurance company.

In contrast, if you outlive the term of a standard term life policy without the return of premium rider, you get nothing back.

A return of premium rider is rarely made available by insurers for whole or universal life insurance policies. The reason is that the rider is designed to trigger a return of your life insurance premiums paid after you outlive the term of the policy, and permanent life insurance policies like whole life and universal life are designed to last your entire life; they don’t have a term you can outlive. 

That being said, some insurers do offer ROP guaranteed universal life insurance policies. These policies give you the option of surrendering your policy at specific points during the life of the policy and receiving back the premiums you paid to that point. 

ROP guaranteed universal life insurance is helpful if you’re 1.) confident you want to buy permanent coverage and 2.) you’re willing to pay for the ability to have your premiums refunded if you experience a significant life event. 

For example, let’s say you bought a guaranteed universal life insurance policy to ensure that you and your spouse would have money to live on during retirement, but your spouse was diagnosed with cancer. You might want the ability to have your premiums returned to you so you can pay for medical expenses.

How Much Does a Return of Premium Rider Cost?

The cost of a return of premium rider will vary by insurer. A word of caution: next to a long-term care rider that you can add to a permanent policy, the return of premium rider is the second most expensive rider you can add. 

For example, the annual cost for a return of premium rider can increase the price of a basic term life insurance policy by as much as 50%. You could be paying $1000 annually for a term life policy and increase your life insurance premium by an additional $500 per year by adding the return of premium rider.

Whenever you buy life insurance, it’s recommended that you compare quotes from multiple insurers. The best life insurance plan for someone else isn’t necessarily the best plan for your situation. 

Pros and Cons of the Return of Premium Rider

Compared to straight term life insurance policies without a rider, a return of premium rider has several benefits and drawbacks you need to consider before completing an application and purchasing coverage.

Pros of the return of premium rider

  • Percentage-wise, only a small percentage of people die when covered by a term life policy. Some estimates put the rate at under 5%. Without the rider, outliving the policy term means all of the premiums you paid are gone, and you and your beneficiaries didn’t receive any financial benefit.
  • With the rider, you didn’t pay all of those premiums for naught. So not only did you outlive the term, which is excellent news for you personally, but you also got every penny back that you paid in premiums to the insurance company. 
  • The ROP rider is helpful for people that aren’t disciplined savers. They may prefer to buy a term policy without the rider and save a bunch in premiums, then invest the difference, but they know themselves and know they would probably spend the difference, not save it. 

For these folks, they may spend more by opting to add the rider from the start, but because of the rider, they’ll have money in the bank if they outlive the term. 

Cons of the return of premium rider

  • The premiums for a term life policy with the rider are significantly higher than those without the rider--as much as 200% higher. 
  • If your policy lapses during the term and you have the rider, you’ll forfeit all of those extra premiums you paid for the rider, meaning you’ll have paid for a benefit you never received. 

Are Return of Premium Riders Worth It?

Let’s run the numbers and see if it’s worth adding a return of premium rider to a term life insurance policy:

Eric, a 36-year-old non-smoker, purchases a 30-year, $250,000 term policy with an annual premium of $560. If he wants a return of premium rider added on, the cost will jump to $880, an increase of $320 annually. Without the rider, Eric will pay a total of $16,860 over the policy's life. The additional rider will bring the total cost of his term policy to $26,400

Will the refund of premiums make it worth paying an additional $9,540 over 30 years? From a financial standpoint, that depends on how much money Eric might earn on the money if he had invested it instead, a financial concept known as “opportunity cost.”

For example, if he invests the additional $320 a year in a stock mutual fund inside a tax-free Roth IRA, in 30 years, the fund could be worth almost $39,000, assuming an annual growth rate of 8%. In this case, Eric would be better off investing the difference than adding the rider to his policy

What if he has a low-risk tolerance or an income that is too high to allow him to contribute to a Roth IRA? Another option would be to invest the money in a taxable savings account paying a 2% interest rate. If Eric is in the 32% tax bracket, this will grow to just under $15,000 at the end of 30 years, after taxes. In this case, the return of premium rider would yield a higher overall return.

So, risk tolerance will be a significant determinant in whether or not it’s worth adding the return of premium rider. A conservative individual who has low risk tolerance and is not comfortable investing in stocks or mutual funds may find the added cost of a return of premium rider to be worth it. 

Conversely, someone who already owns mutual funds through an IRA or a 401(k) where they work may find it advantageous to take the more aggressive path and invest the difference in premiums in equities; as long as they can maintain peace of mind through the market’s ups and downs.

In Summary

If you’re not sure an ROP rider or policy is right for you, ask your financial advisor to provide you with a questionnaire that assesses your risk tolerance. If your advisor can’t help you with this, there are plenty of these questionnaires available that you can find online.

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