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It can be hard to know how much life insurance you need, especially when inflation keeps driving up the cost of living. Gas, housing, eggs: they are much more expensive than 20 years ago. If you buy a policy with today's prices in mind, it might not provide enough for your family to buy groceries or pay the rent in the future.
We may be unable to avoid inflation, but we can prepare for it. Learning to factor in the economy to your coverage can help you stay better prepared for the future.
Calculate for inflation
The primary purpose of life insurance is to provide a safety net for anyone who relies on you financially. For example, if your salary covers the mortgage, utility bills and school fees, a life insurance policy can cover those expenses if you die. Calculating how much life insurance you need may include multiplying your salary by a certain number of years, adding up your debts and considering all the daily expenses you currently cover.
While these calculations are necessary, they don't account for inflation. When you buy coverage through an agent or broker, they may factor in inflation for you. But if you purchase coverage online, you may have to factor this in yourself.
A simple way to do this is to use historical averages. For example, the average annual inflation rate for the 20 years prior to the pandemic (2000 to 2019) was roughly 2%, according to data collected by the Federal Reserve Bank of Minneapolis.
But inflation does not always climb at a steady rate. For example, the consumer price index, which tracks the average cost of goods and services, soared 6% over the past year. So if you factored in a rate of 2% when calculating your coverage, the current rate would feel like a huge gap, says Tanya Frias, chief financial planning officer at Freeman Capital, a financial planning firm.
One way to combat this is to use an inflation rate that is realistic to your needs, Frias says. Your policy type, policy length and financial obligations can help you build a custom plan. For example, planning for 6% annual inflation may not be realistic for a policy that you expect to last 30 years, but it may be practical for short-term coverage that could pay out in the next few years.
Think about the types of expenses you want the policy to cover. Some costs, like fixed mortgage payments, aren't as heavily affected by inflation, while others, like groceries and utilities, can change significantly over time. Speak with an agent or fee-only life insurance advisor to find the right rate for your situation.
Consider a cost-of-living rider
"There are riders available to help insure against external factors like inflation," says Lauren Wybar, a senior wealth advisor with Vanguard Personal Advisor Services. Specifically, a cost-of-living rider increases the death benefit in step with the consumer price index, a marker for inflation. As a result, your premiums will increase alongside any increases made to the coverage amount. However, not all companies offer inflation riders and the cost may differ among insurers.
Buying a new policy during high inflation
Like other consumer products during severe inflation, the cost of new life insurance policies may go up, Wybar says. But holding off until prices level out isn't necessarily the best move. "There's always a risk in waiting," Wybar says. We don't know how long inflationary prices will last and if something happens to you in the interim, you likely would have been better off getting a policy.
"At bare minimum, put a term policy in place," Frias says, preferably with a conversion option. This means you can convert the policy to permanent coverage later without reapplying or taking a medical exam. Term life insurance is the cheapest type of coverage and lasts for a set number of years. It doesn't build cash value like whole life insurance, but the lower premiums mean you can get affordable, temporary coverage while costs are high.
Reassess your coverage regularly
You should review your policy annually as part of a general financial health check, Wybar says. For example, if you go through a significant life event, such as buying a house, getting married or having children, you may need to increase your coverage. Similarly, you may want to lower your death benefit if you no longer need as much coverage. When adjusting the policy's face value, speak with an agent or life insurance advisor about how the new amount should be adjusted for inflation.