Are Return of Premium Riders Worth It?

The answer depends in part on your risk tolerance and tax situation

A return of premium rider provides for a refund of the premiums paid on a term life insurance policy if the policyholder doesn't die during the stated term. This effectively reduces the policyholder's net cost to zero. A policy with a return of premium provision is also referred to as return of premium life insurance.

Key Takeaways

  • A return of premium rider allows term life insurance policyholders to recover the premiums they've paid over the life of their policy if they don't die while the policy is in effect. Policies with this provision are also referred to as return of premium life insurance.
  • Adding a return of premium rider to a term insurance policy may boost its cost substantially.
  • Whether a return of premium rider makes financial sense depends on the likelihood that the policyholder will invest the money elsewhere at a higher return.

How Term Life Insurance and Return of Premium Riders Work

As the name implies, term life insurance provides coverage for a specified term, such as 10, 20, or 30 years. If you die during the term of your coverage, the death benefit goes to the beneficiary or beneficiaries you've designated in the policy. If you outlive the term of the policy, your coverage simply ends. One advantage of term life insurance over permanent life insurance is that it is less expensive.

When you buy a return of premium rider or return of premium life insurance, the insurance company will refund the premiums you've paid if you outlive the term. But this flexibility comes at an extra cost. So is it worth it?

Unlike most types of permanent life insurance, term insurance has no cash value, which means the only value is the guaranteed death benefit if you die.

Weighing Costs and Benefits: An Example

Here's an example of how to calculate the likely cost and potential benefit of a return of premium rider.

John, a 37-year-old non-smoker, purchases a 30-year, $250,000 term policy with annual premiums of $562. If he wants a return of premium rider added on, the cost will jump to $880, an increase of $318 annually. Without the rider, John 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.

Will the refund of premiums make it worth paying an additional $9,540 over 30 years? From a financial standpoint, that depends on how much money John might earn on the money if he invested it instead, a concept known as opportunity cost.

For example, if he invests the additional $318 a year in a stock mutual fund inside a tax-free Roth IRA, in 30 years the fund could be worth a little over $38,906, assuming an annual growth rate of 8%. In this case, John would be better off investing the difference than adding the rider to his policy. But this answer is deceptively simple because the calculation doesn't consider factors such as John's risk tolerance or tax bracket. It also assumes John remembers to keep investing another $318 year after year for three decades.

What if he has a low risk tolerance or an income that is too high to allow him to contribute to a Roth IRA? Another option would be to invest the money in taxable certificates of deposit (CD) paying a 2% interest rate. If John is in the 32% tax bracket, this would grow to a little over $14,760 at the end of 30 years, after taxes. In this case, the return of premium rider would yield a higher overall return.

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 give you an 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 or a term policy.

The Bottom Line

Whether or not to purchase a return of premium rider or return of premium life insurance policy 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.

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