Life insurance is a vital financial planning tool for individuals and businesses. It provides a death benefit that a beneficiary can use to meet various needs, from paying off a mortgage to funding a college education. It can also cover key personnel in an organization so the business can continue to operate if an owner or partner dies.
But what happens when a life insurance policy doesn’t keep up with inflation? On average, consumer prices rise around 2% each year. But during some periods, the consumer price index (CPI) increases much faster. Moreover, not all costs of living are reflected in the CPI, meaning maintaining a lifestyle or a business could be much more expensive than the CPI suggests.
The Bureau of Labor Statistics has a CPI Inflation Calculator that demonstrates the impact of inflation on consumer buying power. For example, if you purchased a $500,000 life insurance policy in 2000, you’d need $930,000 in coverage in 2024 just to keep up with inflation!
Given the importance of life insurance for protecting families and businesses, it’s essential to understand the basics and consider inflation when purchasing a policy.
Decide which type of life insurance is best for you
Whole life insurance: Many life insurance policies are designed to last the entire life of the policyholder. These policies have level premiums and build cash value, but they typically have a fixed death benefit.
Term life insurance: This is a less expensive alternative and can cover you for a fixed term, such as 10, 15, 20, 25 or 30 years. You can apply for additional coverage when you renew your policy. The cost of term life insurance increases as you age. The older you are when your purchase the policy, the higher your premiums will be. It doesn’t accrue any cash value, and you may need a medical exam to qualify for higher coverage.
Blended life insurance: A third option is to supplement a whole-life policy with term insurance when you need additional coverage.
Your agent can help you decide which type of life insurance is best for you and the amount you need based on factors such as your age, health, income, savings, pension survivor benefits, liabilities and future goals. Remember that you can add more coverage later as your needs change or you’re better able to afford it.
Ways to guard against inflation
Your agent can also suggest strategies for guarding against inflation. Here are some to consider:
Take advantage of your company’s group life plan. Many employers offer group life insurance as an employee benefit. The face amount is often a multiple of your annual salary, up to a set limit. Assuming your salary rises each year, these plans are a great way to provide your family with increasing protection at little or no cost to you. Just remember the benefits will end when you leave employment.
Consider a paid-up-additions rider on a whole-life policy. Mutual life insurance companies are known for paying annual dividends on their whole-life policies. You can use these dividends to purchase additional coverage. This allows you to increase your death benefit without incurring higher premiums or triggering additional insurer questions about your status.
Buy increasing term life insurance. Some insurers offer a product known as increasing term insurance. Each plan is slightly different, but all give the policyholder the ability to add coverage to the original face amount. The advantages are that you don’t have to apply and qualify for new coverage and your death benefit will increase over time.
Purchase a cost-of-living-adjustment (COLA) rider. COLA, or inflation-protection, riders are a common feature of many term life policies. It’s best to elect a COLA rider when you first purchase a policy, since they aren’t always available once the policy is in force. The insurance company will use an inflation index, such as the CPI, to adjust the face amount of your policy. Keep in mind a COLA rider will increase your insurance premiums.
Inflation affects all forms of insurance, not just life insurance. But when it comes to protecting your family or business, you’ll want to make sure you’ve taken the steps to make up for the effects of inflation.
