When researching life insurance options at the highest level (Term vs Whole vs Universal), I learned of a policy within the Term family that caught my attention, a policy called Return of Premium Term Life Insurance (or ROP). I quickly got into my analysis mode and decided to compare the Standard Term vs. Return of Premium Term Life Insurance.
What is Return Of Premium Term Life Insurance (ROP)?
The easiest way to explain this policy is think of it as a standard Term where you pay premium for a determined 20 or 30 year period of time (whichever you choose). If you outlive that premium period, you’ll get all the policy premiums you’ve paid back at the end of the term. So for example, let’s say you wanted $500,000 of coverage over a 20 year term. If your yearly premium was $1,500 at the end of 20 years you’ll receive $30,000 back. Sounds too good to be true? One thing to note, ROP’s are typically a lot more expensive than your standard term. In order to really understand the opportunity cost of that difference I decided to compare the two.
The Analysis
To simplify the analysis I am not going to include taxes and I will be using premiums when paid yearly. Using real quotes, let’s compare the premium and rate of return for a 20 year Term and Return of Premium Term Life Insurance (ROP):
ROP | Term | |
Yearly Principal | $3,140 | $800 |
Total Paid | $62,800 | $16,000 |
Return of Principal | $62,800 | $0 |
Stopping your analysis right here makes the ROP look like the clear winner. However, to really determine the winner you would need to find the rate of return on EACH of your yearly principal. In order to do this, we need to create an amortization table to see what our average yearly rate of return would be to cover the premiums of a regular term. When looking at the ROP as an investment:
What this table allows you to find is the average yearly rate of return. It shows you the future value 20 years from today for each year you pay your premium. In this example, if we chose the ROP we would be receiving a return on our investment of only 2.33%.
Still sounds confusing? Think of it this way… For the next 20 years you are depositing $3,140 into a CD at a fixed rate of 2.33%. However, each year you deposit that CD, you are locking it in towards the same end date of 20 years from today:
At the end of 20 years at a fixed investment rate of only 2.33%, the total cumulative dollars you deposited is $62,800 and that future value equates of $78,852 (or a profit of $16,052 which basically covered the total premiums of a standard Term policy).
An alternative way to view the two policies head to head is measure performance by investing the difference. Using the same spreadsheet, we would be looking at depositing $2,340 into a fix CD (or any investment) yearly. In this scenario we would need a return of 2.99% yearly in order to receive an end balance of $62,800 at the end of 20 years.
Conclusion
I can see instances where a 2.33% or 2.99% rate of return can be beneficial for some families. Or even a combination of both Term and ROP to hedge your bet. But based on my analysis, and for my personal situation, the standard term is the winner.
Let me know if you agree or disagree in the comments below!
For copy of my spreadsheet to run what the ROI (return on investment) would be for your ROP vs Term email me at newparentinvest@gmail.com and I’ll be glad to send it along.
Just coming onto this page. I like your comparison and I think your conclusion is correct but one thing you need to consider is a CD is subject to federal and potentially state income tax on the interest. Return of principal is not considered income and thus is not subject to income tax typically. Depending on your tax bracket, this should marginally increase the benefit of the return on principal benefit by 10-30% when compared to a CD subject to income tax (ie to a 20-year CD at 3.1% – 3.3% ish annually). Obviously this still won’t beat investing the difference into the stock market over the long term. Although it will beat a savings account and any current CD rate unless we start to see more hikes in interest rates. My 2 cents.
Hi Dave,
Very good point. I tried to leave taxes out of the analysis but you are 100% correct. For the CDs, I was comparing it to a laddering strategy of purchasing each year to try to balance out the years where rates are low. But ultimately, we do need the rate hikes for this to really prove out over a 20 year term (since rates have been pretty low for the better part of the last 10 years).