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Return of premium life insurance

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There are enough different types of life insurance available that you can be forgiven if you find it all a bit confusing. Within the two main types of policies — term and permanent — there are numerous subtypes, and the challenge for you as a consumer is to find the one with the best possible payout at the lowest cost.

One option is return of premium life insurance. In this report, we’ll take a look at what that means, whether you can save money with it and what the pros and cons mean for you in the long term. Let’s take a closer look at what a return of premium life insurance policy is.

What is return of premium life insurance?

A return of premium life insurance policy is a type of term insurance. What that means is that you’ll be purchasing a policy for a period of years, usually between 10 and 30, and during that time, you’ll be paying premiums on a regular basis. In return, if you were to die during this time, the insurance company would issue a check to your beneficiary for the amount of insurance you had purchased. Once the term of the policy has expired, however, there is no longer a payout.

What makes a policy return of premium insurance is that it has an added element: if you don’t die during the term of the policy, when the policy ends you will receive a check for all the money you paid into it over the years it was in effect.

Return of premium policies are meant for people who want the protection of a life insurance policy, but at a low risk, and with a forced saving component that is in effect for as long as the policy is valid. 

How return of premium life insurance works

How does return of premium life insurance work? Let’s look at an example of a return of premium term life insurance policy. A 33 year old female — we’ll call her Marcy — purchases $300,000 worth of term life insurance for a period of 20 years, which includes the return of premium rider. She names her three children as the beneficiaries. Her annual premium is $800. 

Marcy has two outcomes as far as the policy is concerned. If she dies in the next 20 years, her children will receive a check for $300,000 as the beneficiaries of the policy. But if Marcy doesn’t die within the next 20 years, and pays the premiums until the end, she will receive a check for approximately $16,000, which is her annual premium multiplied by the 20 years of the policy. 

Hybrid policy

Although we’ve said return of premium policies are term policies because they last a certain number of years, they do share one characteristic with permanent policies: they have a cash value. With many types of permanent policies, you will accrue value in your policy as you continue to pay for it over the years. The same can be said for return of premium policies.

Lack of interest paid

There is one important factor to consider with return of premium policies: the money you pay as premiums does not earn interest while it is being held by your insurer. So Marcy’s payout at the end of the term doesn’t account for inflation, and her money is, in a sense, losing value over the 10, 20 or 30 years of the policy. What you get back is, simply, what you paid in.

Tax considerations

Whether a return of premium policy is right for you depends partly on your tax situation. If you do not die during the policy’s term, the money that is returned to you is not considered an investment, and therefore is not taxable income. If Marcy is in a higher tax bracket, this may make it an appealing option for her.

Higher premiums

Another factor worth noting is that return of premium policies are more expensive than other term policies. You should expect to pay at least 30% more for return of premium insurance than you would for a comparable term policy. In other words, for a basic term policy, Marcy might have paid closer to $500 than $800 per year.

Who needs return of premium life insurance?

If you are very risk-averse, a return of premium policy gives you a guaranteed payout, whether you die or not during the term of the policy. In return for the higher premiums, you know you will receive something back from the policy no matter the circumstances. But this can be misleading: if you survive the term, the money you’re getting is your own, not any additional that you’ve gained through investments.

Determining whether return of premium insurance is a good choice for you can take a little work. You’ll want to take a look at the money you’re putting into the policy and decide if you could earn a higher payout by investing the money in some other vehicle, such as an IRA or mutual fund. It’s a good idea to work with a financial advisor on determining the best outcome, unless you are investment-savvy.

Pros and cons of return of premium life insurance

Pros and cons for return of premium insurance policies are indicated by your financial goals. For example, if you are risk-averse and just want to protect your money, it’s a pro that you are guaranteed to receive back the money you’ve invested in premiums. If you have a higher tolerance for risk, however, you might not be as likely to choose a return of premium policy for the simple reason that your money can work harder for you in other investments.

Your current financial situation can also dictate your willingness to consider this type of policy. If you have a tight financial budget but you really need a way to protect your family in the event of your death, you would be better served by simple term insurance, which is considerably cheaper than return of premium coverage.

ProsCons
Premiums are refunded at the end of the term period if you don’t diePremiums more expensive than with regular term policies
Can be less expensive than permanent life insurance (but not term)If you stop paying premiums before the term comes due, you may not get any return
Can act as a forced savings account if you have trouble saving moneyYour premium doesn’t earn interest while being held by the insurer
Can serve as one component of a complex financial strategy for higher-income individualsYou might earn more by investing your money in another, high-rate monetary vehicle

Is return of premium life insurance worth it?

Return of premium insurance may be worth it if you need a life insurance policy, have money available for the higher premiums and want a payout of some sort if you outlive the policy. With a return of premium policy, you won’t ever lose money — either your beneficiaries will receive a payout or you’ll get back everything you paid into it at the end of the term.

But only you can determine if that’s the best way to spend your money. A well-managed mutual fund may earn you enough in interest to make that a better option, if you are willing to take on the minimal risk of this investment. If you are comfortable with higher risk, taking the money you would have paid in premiums and investing in the stock market stands the good chance of earning excellent returns. 

If that appeals to you, you’re better off purchasing a simple term policy for a minimal cost and using any additional money to invest wisely in a way that will allow your money to grow and maintain pace with the economy.

Alternatives to return of premium life insurance

As we’ve already mentioned, simple term life insurance is one good option that you might choose over return of premium policies. Although there is no return of the money you’ve paid in, if your main object is to protect your loved ones in the event of your death, it’s a wise choice.

If the idea of earning back money no matter what appeals to you, consider a permanent life insurance policy. Many of these offer a cash value. Once you have paid into the premiums for a certain amount of time, you can borrow on your policy. Additionally, the policy has the benefit of remaining in effect throughout your life, as long as you pay the premiums. There are several types of permanent life, including whole life, universal life and variable life. 

The takeaway

  • Return of premium life insurance is a type of term policy that pays back your premiums if you survive the policy term.
  • It is a good choice for those who are averse to risk and want a guaranteed return.
  • Return of premium policies are more expensive than simple term and do not protect against inflation.
  • There are no taxes due on the premiums that are returned to you, but neither do they earn interest.

What is return of premium life insurance? Simply put, it’s a policy that pays your beneficiaries if you die during the term of the policy and returns your premium payments to you if you don’t. A return of premium rider may be a good choice if you don’t want too much risk, since you are guaranteed some sort of payout. The policies are roughly 30% more expensive than regular term and do not provide any protection from inflation.

Mary Van Keuren

After 30 years as a writer and editor in academia, Mary now writes full-time for the insurance and finance industries. Her work has appeared on Reviews.com, TheSimpleDollar.com and Bankrate.com, as well as other consumer-focused websites.

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