What is ROP Life Insurance
ROP (Return-of-Premium) life insurance is term insurance that returns either a portion or all of the premiums paid at the end of the term if the insured is alive. For many people the primary benefit of a standard term policy is that it is not expensive. However, it doesn’t build cash value and the premiums paid over the years are lost. A term life insurance policyholder could pay premiums over a 30-year term and feel as if the money has not been spent wisely if he or she is alive at the end of the term. An ROP policy may be a wise choice for those looking for inexpensive term insurance with the benefit of having the money spent on premiums returned if the death benefit is not paid.
How ROP Envelops a Term Policy
A return-of-premium policy envelops an underlying term insurance policy. With ROP term life insurance, the insured pays the premiums as required for the duration of the term. If the death benefit has not been paid by the end of the term, the insurance company returns either a portion or all of the money the policyholder has paid in premiums. In effect, the net cost of the policy then is zero. Not only has the policyholder been insured for the length of the term, he or she hasn’t lost any money.
The amount of the premium on a return-of-premium policy is based on how much of the premium the policyholder wishes to have returned. He or she can choose between the total of all premiums paid or a portion of premiums paid. Premiums will be higher, of course, on policies for which a higher amount is returned. The disadvantage to this type of policy is that if the policyholder dies before the end of the term, the beneficiaries are paid only the face value of the policy, as they would be with a standard term policy.
Unlike a standard term policy, an ROP policy offers a loan option. Because the policy is building cash value that could be returned, a policyholder is able to borrow against his or her policy. While each insurance company sets its own limits regarding loans, this feature can be of great help in the event of illness or the loss of a job.
What is the Expected Return on a Return-of-Premium Policy
A man in the United States has a mere 5% chance of dying before his 61st birthday. Like any insurance policy, the premium on an ROP policy depends on factors such as the age, sex, and health of the insured. But, a 30-year term policy with an ROP wrapper can cost up to two to three times more than a stand-alone term policy. ROP life insurance, however, can be thought of as a savings account, as the difference between the regular term life premium and the ROP premium is saved.
In other words, a fit, non-smoking, 30-year-old man could buy a one million dollar 30-year term policy for about $700 per year. An ROP policy, on the other hand, might cost about $1500. In this case, the premiums on the ROP policy would net over 5%. That return is greater than the return on Treasury bonds and bills. And, the ROP policy has much less risk associated with it than an investment in the stock or bond markets.
Additional Advantages of an ROP Policy
The premiums returned to the policyholder at the end of the term are not taxable, at least not under current tax law. The entire amount of the premium is considered to be the policyholder’s “cost basis”. Cost basis is the amount of the original investment. For example, if an investor purchases a stock for $20 and then sells it for $25, he or she will pay capital gains taxes on the difference ($5).
Most insurance companies also allow a policyholder to convert an ROP term insurance policy for a permanent life policy during the term. This can be especially beneficial for policyholders who need to protect their insurability. It can also be helpful for those looking to build additional cash value through a life insurance policy.
Suitability of Return-of-Premium Life Insurance
An ROP life insurance policy is typically best suited for a young, healthy individual who has dependents to protect. He or she must also commit to paying the premiums according to the terms of the policy. As long as premiums are paid, the policy will remain in force. But, if a lapse in payment occurs, the policyholder will forfeit the return of not only the premiums, but of the death benefit. Underwriting categories vary among insurance companies, but, as with any life insurance product, policyholders in the least risky categories will almost always pay the less in premiums.
ROP policyholders who lack the financial discipline to ensure that premiums are paid in order for the policy to remain in force do have an option. An “enhanced ROP policy” provides an option for the policyholder to borrow against the policy. Typically, a loan can be taken after the policy has been in force for at least 10 years. The premium of an ROP policy with the enhanced option is higher than that of a standard ROP policy, but being able to borrow against it can provide a safety net. And, the policy remains in force even if the policyholder faces an emergency due to divorce, illness, loss of a job or any other type of financial challenge. If the loan is not paid back, the amount is deducted from the amount of money that would be returned at the end of the term.
The money returned at the end of the ROP term is tax-free under Internal Revenue Service guidelines and state tax law, as it is simply the return of the policy owner’s money. As with all insurance products that build cash value over time, it’s important to ensure that the insurance company has at least an A+ or better rating from AM Best, Standard and Poor’s and Moody’s.
