Term life insurance policies protect against financial loss resulting from an untimely death. But unlike whole life insurance, term life insurance policies are in effect only for a limited period of time. If you don't die during your term of coverage, your policy will never pay out.
Although this is how life insurance works, many people don't like the idea of paying premiums for years only to end up with nothing. A return of premium rider solves that by guaranteeing you get back all premiums you paid if you don't die while your coverage is in effect. Return of premium coverage is costlier than standard term life coverage, though, so you should consider the downsides as well as the benefits. This guide can help.
How return of premium life insurance works
When searching for the best life insurance, many people find a term life policy can be a good option. A traditional term life insurance policy typically comes with affordable level premiums that remain the same for the entire time the policy is in effect. But they only pay out a death benefit if you die during the coverage period.
This works for many policyholders because you typically don't need life insurance forever — you usually only need it when someone counts on your income. For example, parents often purchase term life insurance to ensure children are provided for until they reach adulthood. But you could end up paying premiums for 20 or 30 years, only to get nothing from your policy in the end. However, policyholders may choose to purchase a return of premium rider to address this problem.
If you purchase a return of premium rider, you'll make monthly premiums as normal during the whole time your term policy is in effect. If you die during the coverage term, your designated beneficiaries will receive the death benefit. But if you don't die during the coverage term, you receive a refund of 100% of the premiums you paid.
Your premiums are returned in a lump sum at the end of your term life insurance policy, and the money is tax-free. You can do anything you want with it, so this type of policy could essentially act as a savings account that gives you a big pot of money to spend later in life.
How much does return of premium coverage cost?
Return of premium coverage is add-on coverage, and not all insurance companies offer this type of coverage. That means you'll pay your standard premiums for a term life insurance policy, as determined by factors such as your health status, age, the amount of coverage you buy, and the length of your term. And you will also pay an additional fee for the added protection of knowing your premiums will be returned if your death benefit doesn't pay out.
When insurers sell a return of premium policy, the company knows they will be giving out money at some point — either in the form of a death benefit or returned premiums after a set period of time. As a result, they charge more than they would with a standard term life insurance policy where a payout isn't guaranteed.
As a policyholder, your added cost will likely be substantial if you opt for return of premium insurance. The cost of this additional protection is typically added to your standard monthly premium. The total monthly combined premiums you pay are around two to three times higher than they'd be if you just had a term life policy without the return of premium rider.
Pros of return of premium insurance
Return of premium insurance might offer some significant advantages, including the following:
- You'll receive a guaranteed payout when you buy a term life policy: You won't have to worry about paying premiums for decades to end up with nothing when the term of the policy ends.
- Your insurance can act as a type of savings account: The extra money you're paying into your term life insurance each month is like a type of forced savings since you get the money back at the end of the term.
- The returned premiums are tax-free: When you receive your returned premiums, you won't have to worry about giving the IRS a cut.
- The returned premiums can be used for any purpose: You could choose to use your returned premium payments to pay for college for your children, to travel, to help fund your retirement, or to accomplish other big life goals.
Cons of return of premium insurance
Unfortunately, there are also some significant downsides to return of premium coverage:
- You'll pay higher monthly premiums: The cost of your term life policy will likely be much higher than if you buy a term life insurance policy without the return of premium rider.
- There's an opportunity cost due to a low return-on-investment: The money that is returned generally has less cash value than it did when you paid your premiums because of inflation. Money spent on the extra premiums also can't be invested elsewhere, such as in the stock market, where it could earn a reasonable rate of return.
- Not all insurers offer return-of-premium riders: Since this type of additional coverage isn't always an option, you'll be limiting which life insurance companies you can buy a policy from.
- Your family still doesn't get a guaranteed death benefit: One of the key benefits of term life insurance over whole life insurance is the lower premium costs. Return of premium term life coverage is much more expensive than traditional term life insurance. You miss out on the affordability but still don't get the guaranteed death benefit a whole life policy can offer.
Who is return of premium coverage best for?
Return of premium life insurance coverage could be right for you if you don’t want to pay premiums for a term life policy without a guaranteed benefit. If you like the idea of forced savings and getting a large lump sum of money tax-free at the end of your life insurance term, this type of coverage could be a good option.
But remember, you are paying a lot of extra money, which likely could earn you a better rate of return elsewhere.
Which insurers offer return of premium life insurance?
Return of premium life insurance policies are offered as an add-on by many major life insurance companies, including AAA Life Insurance Company and State Farm, though not all insurers offer this coverage. If you are interested in return of premium coverage, shop around carefully and get life insurance quotes from several insurers. Ask if they offer a return of premium rider and see which company's coverage is most affordable.
Are return of premium policies worth it?
In many cases, return of premium policies might not be worth paying for. They are generally much more expensive than regular term life insurance, and the returned premiums could have less buying power due to inflation. You'll also face the opportunity cost associated with paying higher premiums rather than investing the money in assets that could earn a better rate of return.
How much does a return of premium rider cost?
The cost of a return of premium rider varies depending on your insurance company and the specifics of your policy. In general, your term life insurance premiums could be two to three times more expensive if you add a return-of-premium rider than if you just opted for traditional term life insurance without this added coverage.
Return of premium coverage may sound like a smart addition to a standard term life insurance policy since you'll get a guaranteed payout either in the form of your returned premiums or the death benefit your loved ones receive.
But a return of premium rider typically makes insurance a lot more expensive, and many people might be better off sticking with standard term life insurance coverage and investing their money elsewhere.