Recently, a younger business owner client of mine was inquiring about purchasing a term life insurance policy.
For those who are not familiar, the return of premium rider allows the policyholder to get a full refund of all the premiums paid at the end of the contract.
At first, it sounds like a pretty good deal. The most common complaint that consumers have with life insurance is that if you don’t die, all the money goes directly to the life insurance company. If this is the case, then purchasing the return of a premium rider seems totally worth it.
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Cost of Return of Premium Rider
At first glance, the return of premium riders seems like a no-brainer. One piece of information that you need to know is that the rider comes with a price. The ROP rider on average will run 20%-40% higher than purchasing a policy without it.
In addition, you have to keep the policy for the entire contract period to get a full refund of your premium. So then the question remains, does it make sense to pay more for the rider since you know you’re getting all your premiums back? Let’s take a closer look…
ROP Rider vs. Regular Term Insurance
To illustrate the cost difference between purchasing regular term insurance vs. one with the ROP ride, here are some life insurance quotes that I ran.
In our scenario, I am using a 30-year-old male, assuming he is in excellent health. We are going to get a quote on a 30-year term life policy with a $1,000,000 face value.
Without the ROP rider, the annual premium will cost approximately, $720 per year for a total of $21,6000 premiums paid over the 30-year period.
By adding the ROP rider, the premium jumps to $1,180 per year, for a total outlay of $35,400. That’s a total difference of $13,800 in premiums paid ($460 per year) or a 63.88% increase.
Invest the Difference
Since I’m a firm believer of long-term investing, my initial argument would be, to go without the ROP rider and invest the difference. Let’s see how my theory holds up. If we take the difference of $460 per year and invest it and average 6% over the 30-year period, it looks something like this:
By averaging a 6% return, you will have accumulated $36,366 over the 30-year period. Subtract the $21,600 you paid in premiums over that period and your net amount is $14,766.
As you can see in this example, purchasing the ROP rider seems to make sense. Hmmm…..Gets you thinking, right? Now let’s see if we average 8% return:
If we are able to average an 8% return over that same period, we accumulate a total of $52,110, and after subtracting the premiums are left with $30,500.
Compare that to the $35,400 we would get back with the ROP rider, and we’re still in the red. If we can average closer to a 10% return, then we have a greater chance for the normal policy to be more economically viable.
One Major Thing to Consider:
Few More Considerations
I have to admit that the outcome of the scenarios I ran was different than what I predicted. What we have to keep in mind is that when I analyzed the cost differential, we are relying on a few big assumptions:
1. That the person can afford to pay the higher premium.
2. The person will keep the policy for the entire 30-year period.
3. The cost of insurance won’t decrease.
This and other variables would have a dramatic impact on the long-term results of this scenario.
When Does Purchasing ROP Rider Make Sense?
Typically, you wouldn’t purchase ROP on such a long-term policy. Where it is more common is term policies 10 to 15 years in length.
You usually see this being used in buy/sell agreements between business partners where each partner buys insurance on the other’s life. With such a shorter time horizon, the ROP makes more economic sense.
What about you? Have you purchased a term life policy with a ROP rider?
For more information, check out other types of life insurance.
Analyzing the Return of Premium Rider: Costs, Comparisons, and Considerations
|Cost of Return of Premium Rider||ROP Rider Costs 20%-40% More; Requires Full Policy Term for Premium Refund|
|ROP Rider vs. Regular Term Insurance||Compares Costs for a $1M, 30-Year Policy|
Without ROP: $720/Year; With ROP: $1,180/Year; $13,800 More in Premiums (63.88% Increase).
|Invest the Difference||Suggests Investing ROP Cost Difference|
At 6% Return: $14,766 After 30 Years; At 8% Return: $30,500 (Less Than ROP Cost)
|One Major Thing to Consider||ROP Funds Not Adjusted for Inflation; May Reduce Future Purchasing Power|
|Few More Considerations||Emphasizes Affordability, Policy Duration, and Potential Insurance Cost Changes When Evaluating ROP Rider|
|When Does Purchasing ROP Rider Make Sense?||ROP Common in 10-15 Year Policies or Business Buy/Sell Agreements for Economic Viability|
Bottom Line: Should You Invest in Return on Premium Life Insurance?
The Return of Premium (ROP) rider in term life insurance offers a refund of all premiums paid at the end of the contract, seemingly addressing the common complaint that if one doesn’t die, premiums are lost to insurance companies.
However, the ROP rider can cost 20%-40% more. Investing the difference between standard premiums and ROP-inflated premiums can yield better returns, especially over longer terms.
Additionally, the returned ROP amount doesn’t account for inflation. While ROP might make sense for shorter-term policies or specific business arrangements, its economic viability depends on multiple factors, and traditional investing could offer better returns.