There's more going on under the surface of an insurance company than you might think. As a part of preparing to pay claims, insurance companies amass billions of dollars that they need to put somewhere. As such, most insurers are also investment companies and, sometimes, they use that skill set to create investment products for their customers. Return-of-premium term life insurance is one such product and, while it can occasionally compete with a Roth IRA, it's rarely the better choice.
Return of Premium Insurance
In a way, term life insurance is the worst thing you can buy since it's guaranteed that something bad will happen with it. Either your beneficiaries get paid off because you die, or no one gets paid off and you've thrown away thousands of dollars on premiums. A return of premium policy is designed to mitigate the blow. With ROP insurance, you pay a higher premium every month, but you get some or all of what you paid back at the end of the policy's life -- if you're still alive at that point.
How ROP Works
Underneath the insurance part of a ROP policy is a savings plan. In essence, what you're doing is buying two different products with a ROP policy. A small piece of your premium gets used to buy a regular term life insurance policy. The rest of your premium goes into an investment plan that yields a lump sum payment at the end. Furthermore, since ROP is insurance that you buy with taxed money, you get your money out tax-free at the end.
Calculating your return on a ROP policy is relatively simple. All that you have to do is to subtract what you would have paid for term life insurance from the cost of the ROP policy, and look at what your upside is. For instance, if a 20-year term life policy costs $700 per year and a 20-year ROP policy costs $2,000 per year, you're paying $40,000 instead of $14,000 over the life of the policy. This means that, leaving the insurance out, since you'd theoretically be buying that anyways, you're turning $26,000 into $40,000 over 20 years by depositing $1,300 per year and earning some interest. This works out roughly to a 3.94 percent annual return.
Roth IRAs have two key similarities to ROP life policies -- you invest taxed money and you pull out money tax-free. Unlike ROP policies, though, you can only withdraw your returns from your Roth without paying tax if you do it in retirement. However, if you choose to buy a regular term life policy and put the extra money that you would have spent on an ROP policy in a Roth instead, you could come out with a much better return. For instance, if you invested at $1,300 per year at 6 percent instead of at the 3.94 percent return that the ROP policy offers, you'd end up with $50,691 instead of the $40,000 that the ROP option brings. You'd also still have enjoyed 20 years of term life coverage, since you bought it separately. At a 7.5 percent annual return, you'd get $60,518.
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