Life Insurance Premium Returns: Myth Or Reality?

Term life insurance is a type of insurance that provides a death benefit for a specified period of time, typically between 10 and 30 years. If the insured person dies during the specified term, the insurance company pays out a death benefit to the policy's beneficiaries. However, if the policy expires before the insured person's death, there is generally no payout, and the premiums are not returned. While term life insurance policies do not typically return premiums, there is an option called return of premium term life insurance, which refunds all or a portion of the premiums if the insured person lives to the end of the term. This type of policy tends to have much higher premiums than standard term life insurance.

Return-of-premium rider

A return-of-premium rider is an optional addition to a term life insurance policy that ensures you get a refund of the premiums you've paid if you outlive the term. This effectively reduces the policyholder's net cost to zero. Return-of-premium riders are typically available with level-term life insurance policies, where premiums are set when you purchase the policy and remain the same throughout the term.

Adding a return-of-premium rider to a term insurance policy can increase its cost substantially. Whether this makes financial sense depends on the likelihood that the policyholder will invest the money elsewhere at a higher rate of return.

For example, a healthy, non-smoking 37-year-old man purchases a 30-year, $250,000 term policy with annual premiums of $562. If he wants to add a return-of-premium rider, the cost will jump to $880, an increase of $318 annually. Without the rider, he will pay a total of $16,860 over the life of the policy. The additional rider will bring the total cost of his term policy to $26,400.

The payout from a return-of-premium rider is tax-free because it is considered a return of principal.

When is a return-of-premium rider a good idea? If you have an accidental death benefit and expect to reach the policy's expiry date, the rider may provide added benefit. If you want to discontinue the policy before it expires, the rider may also help.

What may be a reason to not invest in one? They are expensive! The premiums are more costly than a traditional term policy.

Whether or not to purchase a return-of-premium rider will depend on your risk tolerance and individual tax situation. For policyholders who can invest in tax-deferred or tax-free accounts and are comfortable with the ups and downs of the stock market, a basic term policy without the rider probably makes more sense. Risk-averse policy owners, however, may find the return of income rider with its guaranteed rate of return more appealing.

Term life insurance vs. permanent life insurance

Term life insurance and permanent life insurance are both designed to protect the financial well-being of your loved ones in the event of your death. However, there are some key differences between the two types of policies.

Length of Protection

Term life insurance provides temporary protection for a set period, typically 10 to 30 years. The policy can often be renewed, but only up to a specific age, and premiums usually increase with each renewal. On the other hand, permanent life insurance is designed to provide long-term, often lifelong, coverage. As long as you continue to pay the premiums, your coverage will remain in force.

Benefits

Term life insurance offers short-term death benefit protection, and your beneficiaries will receive a lump-sum payout if you pass away during the term. Some term life policies also include flexible features that allow you to access benefits early if you become terminally ill or need help with premiums if you become disabled. Permanent life insurance, on the other hand, generally offers long-term death benefit protection and the opportunity to build cash value. This cash value can be particularly useful later in life, as it can be accessed to pay for unexpected emergencies, college tuition, or retirement.

Cost

With term life insurance, your premiums are locked in for the period of coverage you select. If you renew your coverage, the premiums will increase annually. Whole life insurance, the most common type of permanent life insurance, typically starts out more expensive than term life. However, the premiums are locked in at the time of purchase and are guaranteed not to increase. While whole life coverage may be more expensive upfront, it could prove more cost-effective in the long run as it never needs to be renewed, and rates will not adjust with age.

Who Should Choose Term Life Insurance?

Term life insurance is ideal for those who need short-term coverage or additional protection during specific times. It is also a good option for those on a budget or those who want flexibility in case their needs or circumstances change. If you have other financial assets to leave behind as an inheritance, term life insurance may be a suitable choice.

Who Should Choose Permanent Life Insurance?

Permanent life insurance is a good choice for those who need long-term financial protection, want to create an inheritance for their heirs, or seek a tax-advantaged way to save for future expenses. It is also preferable if you prefer stable premiums, which are available with whole life policies.

Extending your coverage

If you still need life insurance after your term policy expires, you have several options for extending your coverage.

Firstly, you could continue your current policy on an annual basis, but this is likely to be expensive. Many term policies have a guaranteed renewability provision that allows you to keep your insurance after the end of the original term as long as you continue to pay the premiums. Your premiums will likely rise each year, based on your current age, but you won't usually have to submit to a new physical exam. Some policies allow you to renew on this basis up to the age of 95.

Secondly, you could convert your term policy into a permanent life insurance policy, such as whole life or universal life insurance. This will also be more expensive, but you may be able to convert to a policy with a smaller death benefit in return for a lower premium. You will need to check your policy or contact your insurance company to find out about any age limits for conversion.

Thirdly, you could shop around for a new term life insurance policy. Some insurers write policies for people up to the age of 80, and you may be able to find an affordable policy if you are in reasonably good health. You will typically need to have a medical exam, especially if the policy is for over a certain amount (e.g. $50,000).

Finally, you could combine several smaller policies to add up to the coverage you need. These smaller policies may not require a physical exam, but they may ask for some health information. You could be eligible for group life insurance through your employer or a trade association, college alumni club, or other organisation. Final expense or burial insurance is another option, which typically has small payouts (e.g. $20,000 or $25,000) and may not require a medical exam.

Converting to a permanent policy

If you want to keep your life insurance after your term policy expires, you may be able to convert it into a permanent policy. This is a good option if you develop health issues, as it will be more cost-effective than applying for a new policy. However, the premium on the new policy will be higher than what you paid for term insurance.

Most major insurance companies offer the option to convert term insurance into a permanent whole life policy. For example, Guardian allows customers to convert level term insurance coverage at any point in the first five years to a permanent life policy. Some companies may also offer an extended conversion rider, which lets you convert at any point during the policy.

When converting to a permanent policy, you may have the option to convert to a policy with a smaller death benefit in return for a lower premium. Conversion rates are based on the original risk class awarded when the policy was first taken out, and you will not usually need to take a new medical exam.

Permanent life insurance policies, such as whole life insurance, are more expensive than term life insurance and can be up to ten times more costly. However, the cost can vary based on personal factors and policy choices.

Shopping for a new policy

When shopping for a new term life insurance policy, it's important to consider your needs and circumstances. Ask yourself how long you need coverage for and how much of a death benefit you want. If you have children, a popular rule of thumb is to choose a term long enough to see them through college. It's also worth considering getting a longer-term policy, as it will generally be more cost-effective and easier to obtain while you're younger and in good health.

Another key consideration is the type of term life insurance policy you want. The most common type is level premium or level-term insurance, where your premium stays the same for the entire term. There are also yearly renewable term policies, which cover you for a year at a time and can be renewed without a medical exam, but at a higher cost. If you want the option to get your premiums back, you can consider a return of premium policy, which pays back all or a portion of your premiums if you live to the end of the term. However, these policies tend to have much higher premiums.

When choosing an insurance company, look for one with strong financial strength ratings and consider whether you want a company that underwrites its own policies. You may also want to look for guaranteed term renewability, which allows you to renew without a medical exam if you become critically ill near the end of your policy's term. Additionally, consider comparing insurance companies by looking at online customer reviews to gauge their ease of communication and claims servicing.

Finally, remember to assess your current financial situation and future needs to determine if you still require life insurance coverage. Consult with a financial advisor or licensed insurance professional to make an informed decision based on your specific circumstances and goals.

Frequently asked questions