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Understanding inflation's effect on term life

The power of time over our money

So like thousands of other Americans every day, you're running a term insurance quote online.  Based on your age, area, and other key demographic information, a list of life insurance rates appear on the screen.  Since it's term life they're relatively inexpensive so you consider increasing the amount or extending the duration.  The numbers jump up quite a bit.  You're looking for that gut sense as to what feels more do-able.  Stop right there!  Before you answer that question, let's first analyze the powerful effect that time has on that life insurance quote and your future ability to pay for it. 

By definition, term life contracts will generally require that you pay the period over a period of time...and quite possibly, a long period of time.  15, 20, 30 year term periods are pretty standard depending on your particular needs.  Even 15 years is a long way from now.  Go back 15 years ago and picture where you were.  Yes...it's that length of time we're discussing.  Funny things happen over such long stretches of a person's life and we're not talking about the widening of certain dimensions or a graying up above.  Money changes over that length of time as well.  What exactly does that mean?  Well, thanks to a nasty little term called inflation, your dollar is losing value each and every year (or at least during most years).

On average, the value that a dollar has or essentially, what a dollar is able to buy is reduced with time.  The average is probably around 3-4% annually.  So that dollar is really worth about 97 cents 12 months from now.  That may not sound like a big deal but multiply that by thousands or hundreds of thousands of dollars or better yet, multiply that percentage by 5, 10 or even 15 years.  You can see how the impact can really add up over time.  How does this affect our term life insurance rates and needs?  Term life insurance is quite different from most other products you buy in that the rate you pay is generally fixed.  It doesn't change over the period of time...even long periods of time.  It might as well be the only product that behaves this way.  When's the last time your cable bill was flat for years.   Even food prices go up over time.  This fixed price function of term life insurance is unique and it adds some interesting kinks to the decision on how much term life insurance to purchase.

First, never purchase more term life than you can afford.  It defeats the purpose to "over-insure" and cancel the policy later on.  That being said, keep in mind that inflation will be de-valuing not only the benefit you expect to receive but the premium you expect to pay.  Let's take a look at both sides.  First, the benefit.  Let's say you make $50K annually now and you want to adequately cover the next 10 years in terms of income replacement.  You come up with $500K.  You're making decision based on today's value of money and today's financial needs.  Let's go out to the end of the term, 10 years from now.  Assuming an annually inflation rate of 4% (hopefully), that's a 40% decrease in the real purchasing value of that $500K benefit if it's needed in the last year.  Really, that benefit will feel like $300K does today.  The longer the period, the more pronounced this decrease in value.  In some respects, it might still work out since you figure that you were able to earn the other 9 years if you don't trigger benefits until the 10th but it's important to keep this inflationary effect in mind.

Now let's look at the other side of the arrangement.  In the above example, let's say the $500K benefit cost you $50 monthly.  Maybe $1M term life benefit would cost you $85/monthly.  On one hand, that's $35 more per month.  Now, let's go out 10 years from now.  That $50 premium will really feel like $30 in today's money (due to inflation).  That $85 will fee about like the original $50.  Inflation can work on both fronts and in the case of premium, it's in our favor.  When you're running your term insurance quote, especially for longer periods of time, make sure to keep in mind the power of inflation both for and against us in the decision. 




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