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Free Life Insurance? Not Really

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By Jeff Brown

It seems like a deal that�s too good to be true: Pay premiums on your term-life insurance policy, then get them all back if you don�t die during the 10, 20 or 30 years you are covered. It�s like getting insurance for free.

But like most too-good-to-be-true deals, this one isn�t quite as good as it appears. Most people can do better with a standard term policy. So-called return-of-premium options were devised a number of years ago to boost sales of term policies, the simplest and least expensive type of life insurance. With term, the policy holder pays an annual or semiannual premium in exchange for a death benefit for survivors.

But the benefit is paid only if the policy holder dies within the period, or term, covered by the policy. Die later and the survivors get nothing, and the premiums seem to have been wasted.

That encouraged lots of potential customers to opt for variable, universal or whole-life policies that cover the policy holder for life and build up a cash value.

The return-of-premium option on term policies is meant to attract customers who want something to show for years of premium payments if they outlive their policies and their survivors don�t collect a death benefit. The premium is not returned if you die with the policy in effect and a death benefit is paid.

But you have to pay a larger premium to get this option, wiping out much of its value, if not all of it.

Transamerica Life Insurance (Stock Quote: AEG) offers a 40-year-old nonsmoking male a 30-year term policy for $800 a year. An identical policy with the return of principal feature costs $1,335 a year.

With the ROP policy you would get back the $40,050 spent on the premiums over 30 years.

But if you took the cheaper policy and invested the $535-per-year savings at 6% a year, it would increase to $40,050 in just less than 29 years, according to the BankingMyWay Savings Goal Calculator.

Chances of averaging 6% over such a long period are pretty good. The Standard & Poor�s 500 returned about 10% a year in the 20th century, and you could invest in that through an index fund like Vanguard 500 Fund (Stock Quote: VFINX), or an exchange-traded fund like the SPDR 500 (Stock Quote: SPY.)

Earn more than 6% and you�d almost certainly be better off investing rather than buying the more expensive policy.

The returned premium is tax free, so a taxable investment would probably have to earn 7% or 8% to provide the same value after taxes were paid. Taxes would not be a factor if you chose a tax-free investment like a Roth IRA.

If you can afford the larger premium it would probably be better to use it for more coverage rather than a return-of-premium option. Use the BankingMyWay Insurance Shopping Tool to find a good policy.