Regular Term Life Or Return Of Premium?

If you’re looking at term life insurance, you might be considering a return of premium policy. Return of premium policies are more expensive than traditional term policies, but you get all of your premiums back at the end of the term, assuming you’re still alive.

Determining whether return of premium life insurance is a good choice depends a lot on your own habits, goals, and tolerance for risk. Let’s consider a hypothetical situation of a 35 year old female who is looking for a $1 million, 30 year term policy. Let’s say she can purchase a traditional term policy for $650/year, or a return of premium policy for $1175/year.

If she buys the traditional term policy, she will spend $19,500 on the coverage over the course of 30 years ($650 x 30). This money is gone forever, but it has done its job of purchasing peace of mind for her and her family.

If she buys the return of premium policy, she will spend $35,250 on the coverage ($1175 x 30), but if she is alive at the end of the 30 year term, she will get the entire amount back. This option costs a total of $15,750 more than the traditional term policy, so the trade off between the two policies is what she could have done with that money if she had purchased the traditional policy instead.

Here’s where an investment calculator comes in handy. The return of premium policy will cost $525 more per year than the traditional term policy. We can use an investment calculator to determine what sort of return she would have to get on that money if she invested it on her own, in order to end up with at least a total of $35,250 at the end of 30 years (since that’s the amount she will end up with if she buys the return of premium policy).

There are numerous online investment calculators that you can use. Each person’s situation will be different in terms of taxes (ie, one person might choose to invest the difference between the premiums in a traditional IRA, with tax-deferred growth, while another person might put the money into a taxable brokerage account) so I’m focusing solely on the growth of the money without taking taxes into consideration. Here is an example of a simple calculator that you can use to determine the effective rate of return that the return of premium policy is giving you.  For our hypothetical lady, we can input 30 years, an initial principal of zero dollars, and an annual investment of $525.  We can reduce the tax rate to 0%, but if she is investing her money in a taxable account, that amount will have to be increased.  Then we can move the little blue arrow on the rate of return line until the investment total (in blue at the top of the calculator) gets to at least $35,250.  For our lady, this happens at 4.8%, at which point, her investment would be worth $35,324 after 30 years (if she invested her money in a taxable account, her rate of return would have to be higher to offset the loss to taxes).

So if this lady were to get average returns of more than 4.8% in another investment vehicle, she would be better off getting the traditional term policy.  But if she likes the idea of a guaranteed rate of return and forced savings, she might be better off with the return of premium policy.  The final decision will be up to you, but understanding the numbers behind the premiums will likely make the decision easier.

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