Comparing ROP to Term Life Insurance
The major advantage of standard term life insurance is that it is inexpensive. The disadvantages are that it neither builds cash value nor returns any portion of the premium. The policyholder may pay monthly premiums for 20 years or more and, if alive at the end of the term, feel as if the money has been spent for naught. For those concerned about living past the end of the term, a return-of-premium policy may provide a solution.
ROP is most easily understood as a wrapper around an underlying term policy. With an ROP term life insurance policy, the policyholder pays the premiums for the length of the term just as he or she would with standard term insurance. But, if he or she is still alive at the end of the term, he or she receives all or a portion of the premiums back, which leaves the net cost of the policy zero. (The amount of returned premium depends on choices made by the insured.) Should the insured die within the term, his or her beneficiaries still receive the death benefit just as they would with a regular term policy.
The two primary benefits of a return-on-premium policy over a standard term policy is that it offers cash back and has a loan option. This can be of great help in estate and retirement planning as the money that is returned can be used for retirement travel, to pay off a mortgage, to leave for grandchildren for education expenses or for whatever the policy owner chooses. As long as premiums are paid according to the terms of the policy, the money will be returned.
The amount of the premium paid on a return-of-premium policy is based on the type of contract chosen. An account owner can choose to have the entire amount of the policy returned or a portion. The higher the amount returned, the higher the premium.
Calculating the Return on a Return-of-Premium Policy
According to statistics, the risk of a man in the United States dying before his 61st birthday is merely 5%. Depending on factors like the age, sex and health of the insured, an ROP policy with a term of 30 years can cost anywhere from two to three times more than a standard term life insurance policy. But, ROP insurance can be viewed very much like a savings account because the difference between the term life premium and the ROP premium is saved.
For example, a healthy, 30-year-old man can purchase a one million dollar 30-year term policy for around $700 per year. An ROP policy for that same individual may cost around $1500. The ROP premiums on this policy would yield over 5%, which not only beats the return for most years on Treasury bonds and bills, but also incurs substantially less risk than investing in the stock market.
Preventing a Lapse in the Policy
Insurance companies can offer affordable ROP policies for two reasons: First, the number of policyholders who die during the term is a relatively small number. Second, and most important, is what the insurance industry refers to as the “lapse rate”. The lapse rate is either the total number or the percentage of policyholders who allow their term policies to expire before the end of the term.
A policyholder who purchases an ROP policy for a term of 30 years and then lets the policy lapse in year 12 forfeits not only the potential death benefit paid to his or her beneficiary, but also the majority of the return of premiums at the end of the term.
The “surrender value” or the amount paid when a policy lapses is usually minimal. While most insurers will return something if a policyholder surrenders a return-of-premium policy before the end of the term, it doesn’t amount to much. The return rate varies among insurers but may not exceed 9% of the premiums paid if the policy is surrendered between 10 and 15 years into a 30-year term policy.
Who Benefits from Return-of-Premium Life Insurance?
As with standard term life insurance, an ROP policy is best suited for young, healthy individuals with dependents to protect who can afford the higher premiums. But, because of the additional element of having the money returned, any ROP policyholder must remain financially disciplined each and every year of the term.
In order to get the premiums returned, the policyholder must continue to pay premiums according to the terms of the policy. While underwriting classes vary from company to company, as with all life insurance, those in the Preferred Plus and the Nonsmoker classes will likely pay the least amount in premiums.
For those who may not be as disciplined financially as they need to be to ensure that an ROP policy remains in force, there is an option. An “enhanced ROP policy” allows the policyholder to borrow against the policy. While the number of years varies among life insurance companies, a policyholder can typically borrow against the policy after 10 years.
The enhanced ROP policy is more expensive than a standard ROP policy, but the ability to borrow against it can provide a safety net that allows the policy to remain in force should the policyholder need emergency cash due to divorce, illness, loss of employment or any number of other financially challenging events. The policyholder has the option of paying the loan back or not. If he or she does not pay the loan back, it is simply deducted from the amount returned at the end of the term.
The premium returned on an ROP policy is tax-free under both federal and state tax law, as it is considered to be a return of the policyholder’s money. As with any policy or product that builds cash value over a significant number of years, it’s imperative to make sure the insurance company has at least an A+ or better rating from AM Best, Standard and Poor’s and Moody’s.
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