Under Certain Terms, This Life Insurance Pays Off

By Michelle Singletary
Thursday, November 2, 2006

Many people scoff at us buyers of term life insurance. They claim we're suckers for paying out hundreds of dollars a year for a policy we can't collect on while we're alive.

That sums up several comments I fielded in a recent online discussion with Kimberly Lankford, author of "The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need." Her book was the Color of Money Book Club pick for October.

"I've never understood why people would choose term insurance over whole life," one reader wrote. "Term insurance ends. If you don't die during the policy term, then the money has pretty much gone to waste. Why not take out a whole life policy where you can always get the money back?"

With Lankford's help, I wanted to answer this reader's question.

First, here's a quick primer on the difference between term and whole life insurance, the latter of which falls into the broad category of "permanent life insurance."

Term life insurance is not unlike buying insurance to protect your home or car. Like those two products, you buy term life insurance for a specified period of time. Under term insurance, when the policy runs out, you typically get nothing back.

I say typically because there's a new version of term life insurance that's a lower-cost alternative to permanent insurance. A "return-of-premium" policy will give you back all the money you paid to cover yourself under a term life insurance policy -- provided you are still alive when the policy's term is up.

As Lankford points out in "The Insurance Maze," your annual premiums under a return-of-premium policy will be higher, but you get a lump sum after 20 or 30 years. For example, a 41-year-old man could pay about $405 for a regular-term policy with a $500,000 death benefit. If that same man bought a return-of-premium policy, he could expect to pay about $1,330 a year, all of which he would get back at the end of the term. That's $26,600 over 20 years tax-free because you're getting back your premiums.

"This type of policy can help people feel better if they don't like the idea of paying premiums for years but getting nothing if they're still alive when the term is up," Lankford writes in her book.

A typical return-of-premium policy might cost about 25 to 50 percent more per year than a regular-term policy. The insurance company takes the extra amount you pay and invests it -- that's how you get your premiums back.

Such a guarantee makes this type of policy not a bad deal if you keep the policy up.

To be sure it's right for you, do the math, Lankford says. For instance, if you took the difference in what you pay annually for the term life insurance policy and the return-of-premium policy ($925 in Lankford's example) and invested it, you would only need to earn an annual interest rate of more than 2.8 percent (before inflation) to beat what you get with the return-of-premium policy, she points out.

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