Sorry the blog has been quiet for a couple days. I went to a conference out of state and it interfered with my writing schedule. That combined with the delay I need to get my blog material reviewed by compliance results in a few missed days. Thanks for being patient. The good news is the conference was good and I will be writing about some of the topics in the near future.
Last October I wrote about Return of Premium Term Life Insurance. I have been considering return of premium (ROP) as an option for several clients and the results are very interesting. In some cases, ROP makes a lot of sense and in others it doesn't. It all depends on the rate of return you would need to earn if you purchased a regular term and invested the difference in a side fund.
Calculating the raw return of the return of premium policy is straightforward. Here are the variables which can be plugged into any financial calculator:
- N = number of years
- PV = 0
- PMT = the difference between the annual cost of a straight term and the ROP term
- FV = annual cost of the ROP term multiplied by the number of years
- For greatest accuracy all payments should occur at the BEGINNING of the period.
- Calculate for INT/yr.
Recently I have been giving a lot of thought to the tax effect of this analysis. If you purchase ROP term, the money you receive at the end of the term is not taxable since there is no gain … it is a return of the premiums you paid. However, if you purchase the regular term and invest in a side fund, the gains in the side fund will be taxable. In order to calculate the tax effective rate of return of the ROP policy, you need to add the tax liability to the future value so you have the same net result after taxes.
I've made it easy for you. Here is an excel spreadsheet (Download rop_analysis.xls) to do the math for you. All you need to do is provide the cost of the regular term, the cost of the ROP term, the term period, and a tax rate. The spread sheet will calculate both the raw return and the tax effective return of the ROP policy.
Keep in mind that the raw return is guaranteed by the issuing insurance company. The effective return is based on that guaranteed return and the tax rate you provide. If the tax effective return is attractive, purchasing ROP makes a lot of sense considering the very low risk.