We often get asked about how life insurance treats inflation. Does the death benefit get adjusted over time to reflect inflation?
The short answer: no.
The slightly longer answer: the vast majority of term life insurance policies in the market do not even offer this option, and we generally do not recommend it.
If your goal is to cost-effectively protect your loved ones from the risk that you die prematurely, a term life insurance policy without inflation adjustment is usually your best bet.
When you consider permanent life insurance policies, many of those policies include some type of feature that leads to growth over time. However, permanent insurance is more complex and expensive (think ~6-10x the premiums of term), so if your main goal is to address the risk that you die prematurely and leave loved ones in a tough spot, save yourself the time and hassle, and focus on term. (To learn more about term vs. permanent, check out Video: What Are the Different Types of Life Insurance? A Quick Overview)
While permanent insurance can be a great choice for some people in some situations, you should never buy a permanent life insurance policy mainly because of inflation protection features.
The push and pull: inflation is often more than offset by declining insurance need
It is reasonable to think about inflation: unless you die in the next couple of years, the money your beneficiaries receive will buy noticeably less than what it could buy today, due to inflation.
But there's another factor to consider, which leads many people to be comfortable with no inflation adjustment: your life insurance need is very likely to decline over time, if you are insured for a reasonable amount in the first place.
When you get your personalized life insurance coverage calculation it will recommend the amount that your loved ones would need if you died tomorrow. If you are a 35 year old with newborn twins and you want to stand ready to provide financial support until they are 25 years old, our calculation will suggest the coverage amount you'd need to replace those 25 years of income that your babies are counting on.
But for every year that you live and work (or provide care for free) you have one less year that you need to insure.
For many people, your insurance need is likely to decrease over time in the way described above - kids get older and closer to independence, mortgages get paid down, you work and save for more years, etc.
This decreasing need over time often more than offsets the impact of inflation.
When planning for inflation could matter a bit more
If you are looking at doing a ladder, you should spend a moment making sure you are thinking about inflation.
Why? Because a ladder commits you, today, to have much less life insurance in the future. Unlike when you have a single policy, you do not offset inflation against a declining need over time. A ladder locks you in to a large future decrease in coverage.
So you want to make sure your sense of what is "enough" many years from now is going to deliver for your loved ones.
Example: you want your beneficiaries to feel like they have $2 million of "buying power" at today's prices, but you want them to have that 20 years from now.
Our recommendation is generally that you assume 2% - 3% annual inflation -- you can always ask your AboveBoard team to do this math for you after you get a life insurance quote.
That calculation would be:
If assuming 3% inflation: $2,000,000 * (1+ 3%)^20 = $3,612,222 => target having $3.6 million in 20 years
If you assume 2% or 2.5% that is not out of the range of reasonable possibility, but it creates more risk of inflation being higher than what you assumed. Here's what it would be at 2%:
If assuming 2% inflation: $2,000,000 * (1+ 2%)^20 = $2,971,895 => apply for $3.0 million
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