Return This to Sender

When you combine naive consumers with the marketing acumen of the financial services industry, the final result isn't pretty. Everyone loves to bash the insurance industry, but without gullible people, there would be no market for its wares. With that in mind, let's take a Foolish look at return-of-premium term life insurance.

Term insurance pays a death benefit to a covered individual for a specific period. At the end of that period, the policy has no value. But with a return-of-premium rider, you get all the premium payments back at the end of the specified term.

Consider this example: Two young men, Jim and Bryan, both are 30 years old and need $500,000 in life insurance coverage. Jim decides to buy a $500,000 term life insurance policy for 30 years, for which he'll pay a $460 annual premium. But Bryan is worried that if he makes premium payments for 30 years, and he's still living at the end of that period, he will have wasted his money.

A slick salesman tells Bryan about return-of-premium term life insurance. Even though the premium is higher ($667.80 for a similar policy), Bryan thinks he got a good deal. "There's nothing to lose -- you get all that money you paid in back," he chortles to Jim the next time they see each other.

But Bryan made a bad decision. Even though the return-of-premium policy will return all premiums after 30 years, the conventional term policy is the Foolish solution. If you invest the difference between the two policies ($207.80) every year and assume a 10% annualized return, your nest egg will grow to more than $37,000, contrasted with the $20,034 in returned premiums. Compound interest -- gotta love it.

Return-of-premium polices are a marketing ruse, and buying one is a small-f foolish idea. For more detailed financial advice, try a free trial to our new GreenLight personal finance service. There, we'll give you the lowdown on more products to avoid.

Fool contributor Buz Livingston, CFP, likes to kayak in the Gulf of Mexico and believes most investors will benefit from professional advice. The Motley Fool is investors writing for investors.

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