Life insurance and inflation don’t go together really well. Considering the continually changing nature of the economy, perhaps the biggest threat to our life insurance and future wealth is inflation.
With the rate of inflation being unpredictable, it can wreak havoc on many of your assets in the future. It can also have an adverse effect on your life insurance benefits.
Your goal in taking out life insurance is to have financial protection for your family in the future. But, with changing economic situations in the coming years, inflation may negatively affect the financial protection plan you set aside.
The danger with inflation is that loved ones could suffer immensely and be left with a fraction of the coverage they were expecting from your life insurance policy.
WHAT IS INFLATION?
According to InvestorWords.com, Inflation is a general upward price movement of goods and services.
Over time, as the cost of products and services increase, the value of a dollar will be reduced and a person won’t be able to purchase as much with that dollar they previously could.
Thanks to this ill-tempered thing called inflation, your dollar is losing value every year. The average is roughly about 3-4% annually. So the dollar in your pocket today is worth about 97 cents a year from now.
That may not seem like a big deal but multiply that by thousands of dollars, and then multiply the 4% by ten years, and you can see how the impact of inflation can add up over time.
Term life insurance – insurance coverage that lasts from 1-30 years depending on the term you choose. You pay a fixed premium for the length of coverage and the death benefit does not change. Your beneficiary will receive the same benefit amount whether you die tomorrow or after 25 years.
Therefore, if you have $500,000 term life insurance policy, as long as you keep paying the premium your beneficiary will get a $500,000 payout from the day you get approved until you pass away.
If you are counting on providing the equivalent of $500,000 to your family and you lived ten years. They would receive the $500,000 all right, but they would only be able to buy $332,416 worth of goods, services, or replacement income with it.
|Year No. Year||Face Amount||Inflation Rate||Purchasing Power|
| Inflation |
Basically, the purchasing power of the dollar decreases by 3-4% per year in relation to inflation.
With insurance, the dollar amount of the death benefit stays the same at $500,000. Every year that passes, the less value your beneficiary will receive. That is why choosing the right amount of insurance coverage becomes harder because you have to project how big inflation will take out of the final benefit.
Because of inflation the amount of insurance coverage you can buy today will not have the same value 10 years from now. Assuming a 4% inflation rate for over ten years, your insurance policy would worth at least 40% less on the tenth year and could be worse with the compounding effect of inflation.
So, after ten years a $500,000 insurance coverage policy will only have the purchasing power of $332,416.32.
LIFE INSURANCE AND INFLATION
Traditionally, the inflation rate in the U.S. is considered to be about 3-4% every year. While it doesn’t appear like much at first, even a small deviation from this rate of increase can have far-reaching effects over the course of two decades.
Think about it. Every year, the dollar in your pocket is worth 4% less, making it harder and harder to purchase anything.
How can you predict whether the investment you’re building into your life insurance policy will be sufficient enough to provide your family with the protection they require; the hard part is that you can’t.
Without a doubt you can do the calculation upfront and figure out what your policy’s face amount should be down the line, taking into consideration perhaps a little higher than the expected 4% inflation rate. However, there’s no way to eliminate the damage done to the death benefit of your policy.
No matter what, your investment will be significantly affected, leaving your beneficiary a lesser benefit than what you intended.
It will require you to outrageously increase the amount of money you put into your policy. Gratefully, you do have some other options on how you can protect your life insurance policy from falling victim to the cruelness of inflation.
It is essential to determine your current insurance coverage needs, although it is sure to change in the future. To estimate your future coverage needs, you need to take a closer look at inflation and changes in your personal circumstances.
If you compute your life insurance needs on your recent income and today’s cost of living, you are possibly shortchanging your family’s future. Because the purchasing power of your money in the future is affected by inflation, thereby affecting your future life insurance needs.
Make sure to make allowance for increases in the cost of living as you ensure your family’s current and financial security in the future.
Other life insurance needs that may also be affected by inflation are college education and mortgage obligations costs.
If you are thinking of buying a new house or sending your child to college, you should increase your life insurance coverage to cover the rising costs.
THE EFFECT OF INFLATION ON TERM LIFE INSURANCE POLICIES
A term life insurance policy is generally paid over an extended period of time (typically 10, 20 or 30 years). The premium you pay for term life is a fixed amount that you pay over the term of the policy.
Therefore, because the rate of inflation is commonly in the range of about 3-4% annually, the value of the dollar decreases by this percentage each year.
This means the purchasing power of the dollar is reduced and it is not able to buy the same amount of coverage benefit in terms of the amount as the previous year. The premium you pay per month for life insurance today will be the same, but it will be less money ten years from now because of inflation.
Take this example, you can buy a 50 cents candy today, but that same candy will cost 55 cents 10 years from now because of inflation.
HOW TO PROTECT YOUR POLICY FROM INFLATION
A common concern of those who take out life insurance policies is the effect of inflation on the real value of the death benefit payout their family will receive in the event of their death.
While the death benefit can seem like a good sum today, ten years from now, you might find that the payout in real terms to your beneficiary may not be enough for them to pay off all of their financial obligations or maintain their standard of living.
A policy rider is a clause built into the policy that provides extra protection. It also includes some other customized benefit that was not included in a standard plan. In this case, some life insurance carriers will offer one – at an additional cost that protects against inflation, often by giving a monthly benefit that increases every year to offset the economic conditions.
This rider is more popular among long-term care insurance but it is gaining popularity among life insurance companies. Ask your life insurance provider if there is such an option on your policy. As always, it’s much easier to make these decisions when you’re just starting a new plan.
Cost of living rider: If you worry that inflation will eat the value of your insurance policy’s death benefit that it may not be enough for your survivors, consider the cost of living rider.
This clause directs your insurance company to increase the death benefit – sometimes once a year, other times every few years – in relation to the Consumer Price Index. Keep in mind that your increased death benefit means an increase in premiums.
This rider can be purchased with many different types of life insurance policies. This type of coverage is specifically designed to help you hedge against inflation.
For example, if you buy this type of coverage, your policy is going to increase in value if inflation rises. If you purchase a policy and then die 20 years later, there will be some inflation during this time. With this coverage, your beneficiary would actually receive more than the face amount of the policy because of the cost-of-living rider.
Periodic Coverage Boosts:
Less elegant than the above solution, this one involves injecting additional coverage into your policy on a regular basis to cover inflationary needs. Buying additional coverage every few years is a good option to hedge against inflation.
For example, if you have a $200,000 ten-year term insurance you could buy another policy after five years to boost your coverage and in effect extend your coverage for 15 years.
Of course, you could buy another policy after 10 years for say $150,000 to continue to cover the loss because of inflation and extend the policy another 5 years.
One problem with this method is that you may not qualify for coverage due to illness or accident and may not be able to continue to buy new policies.
Another problem is that life insurance tends to get more costly the older you get. Nevertheless, lifespans are getting longer, and insurance carriers have been able to reduce their rates overall, and it tends to counteract the age issue to some extent.
There’s hope for the future. Naturally, as the years’ pass, your expenses will decrease. Your children grow up and move out of your house reducing your expenses. You may have even been able to pay off your mortgage too.
Your need for additional life insurance coverage decreases as your own expenses are reduced, and your money, even with inflation taken into consideration may stretch a little further in the event of a life insurance benefit payout.
Also, hopefully, your savings will increase as well as the value of your investments, offsetting the outcome that inflation may have on your ability to provide for your family after your demise.
How you do this is entirely up to you. You can allocate additional funds to an existing plan, or you can purchase a wholly new term policy to extend your coverage into the future.
The choice is yours to make, but this may be a more reliable solution than factoring the inflation rate into your long-term life insurance needs in one sway, as it gives you the option of correcting along the way.
Calculating the impact that inflation will cumulatively have on your life insurance policy is a vital part of planning your financial future.
Your insurance policy is designed to be a safety net that provides protection to your family in your demise, and without doing your utmost best to assess the dangers that await you, it’s nearly impossible to strengthen the structure of your policy to provide the best possible security available to you.
Inflation protection is an integral part of your financial plan’s long-term success, so don’t delay in taking the necessary action.