When it comes to life insurance, most people focus on the difference in premium costs between term and whole life. On the surface, whole life can be more expensive than term insurance. But, as the saying goes, you get what you pay for. And, when you account for inflation, with term life insurance you actually get less than what you pay for.
What is Inflation?
Inflation is the steady increase in the general level of prices for goods and services. During inflation, your money buys a smaller percentage of a good or service (Investopedia.com). The United States economy sees an average inflation of 3.2% per year, when averaging annual inflation over the past 91 years, since the start of the Great Depression.
The Fed tries to maintain a steady 2% inflation rate per year to ensure stable economic growth. However, that number drops drastically in years of economic turmoil, like during the Great Recession and the current coronavirus pandemic. Inversely, in years of great prosperity inflation rates can jump by as much as 18%, seen in the years immediately following the end of WWII.
The exact cause of inflation cannot be determined. However, these are two theories that are generally accepted:
- Demand-Pull Inflation: Inflation resulting from the demand for goods growing faster than supply. This cause usually occurs in growing economies and is the most common type of inflation.
- Cost-Push Inflation: Companies’ costs increase when they need to increase prices to keep their profit margins steady. Examples of cost increases could possibly be due to a shortage of resources, the need for more expensive equipment, changes in shipping, tariffs, or the need for more employees.
Regardless of the type of inflation, both decrease your purchasing power—the amount of tangible goods that money can buy. The value of money is measured in purchasing power.
Variations on Inflation:
- Deflation: When the general level of prices decreases. This is the opposite of inflation. The most deflation we’ve experienced as a country in the last 100 years happened during the Great Depression.
- Hyperinflation: Unusually rapid inflation. This is an extreme case of inflation, which can collapse a country’s monetary system, and usually happens when governments print flat currency without restrain. For example, in 1923 Germany experienced the shocking yearly inflation rate of 325 million percent, which meant inflation was causing the cost of goods to increase every two days (Mint.com).
- Stagflation: A situation where inflation is high, the economic growth rate slows, and unemployment is steadily high. This has occurred in industrialized countries during the 1970s, when a bad economy was combined with inflated oil prices (USeconomy.com).
The Creature from Jekyll Island by G. Edward Griffin goes into great detail on inflation, the history, and the affects inflation has had.
Protecting Your Money Against Inflation
If you ever win the lottery and are offered a lump sum payout vs. a steady stream of income payments over a period of years, always take the lump sum! Every day that goes by makes the value of each of your dollars less and less, due to to inflation. (Not to mention the lost opportunity cost by not investing your winnings from day one!)
Inflation affects every dollar you’ll ever own, and its effect is especially pronounced on the dollars you try to save. The money in your savings account loses value the longer it sits waiting to be spent. Your financial planner will remind you to factor for inflation when it comes to funding your retirement (and to factor for taxes, which add even more unpredictability to your 401(k) or IRA). And if you buy term life insurance, your beneficiary will not receive as much of a death benefit as you originally purchased.
If you purchase a 30-year term life insurance policy with a $1,000,000 death benefit and die near the end of your term policy, given a 3% inflation rate per year, your death benefit will only have the spending power of $411,987 in today’s dollars. In order to pass on the equivalent of $1,000,000 in spending power to your beneficiary, you would need a death benefit of $2,427,262. (And if you died in year 31, your term policy would be expired. Your beneficiary would get nothing.)
However, if you had purchased whole life insurance instead of term, the death benefit of your policy would have continued to grow, based on guaranteed interest and non-guaranteed dividends, averaging 4-6% per year. At this rate, your death benefit would outpace inflation, ensuring your beneficiary receives the full value and spending power your death benefit intended.
When you factor in the cost of buying additional term life insurance coverage to keep up with inflation—and rising premiums when you add coverage at a later date (assuming you qualify), you may better off buying a whole life insurance policy instead.
Additional Ways Whole Life Insurance Outperforms Inflation
Having liquidity during inflation and keeping our money safe during deflation can be a difficult balance.
Whole life insurance policies offer the best of both worlds.
Whole life insurance policies earn cash value through interest and dividends. This capital is liquid and can be used at any time. However, the cash value of your policy continues to grow even when you are borrowing against it with a policy loan. In this way, each dollar of cash value works twice as hard to combat inflation.
Another advantage of whole life insurance over traditional investing is that your returns are guaranteed. Each policy is backed by a mutual insurance company that guarantees a set interest rate, so you know—at a minimum—how much your policy will grow in value year over year.
A whole life insurance policy also earns non-guaranteed returns, based on the performance of the insurance company. As a policy holder, you are entitled to reap the benefits of an insurance company’s good year. In fact, most insurance companies have paid out dividends to their policy holders consistently for nearly 200 years.
As you can see, money in a whole life insurance policy grows to outpace inflation and provided your beneficiary with more security. It also grows faster than in a savings account, making whole life insurance an optimal place to safely store your wealth. Because money in a whole life insurance policy isn’t subject to market downturns like your 401(k) or IRA, it’s easier to plan for retirement and have peace of mind, knowing you’ll have enough money to last a lifetime. Finally, whole life insurance offers unique tax advantages that allow you to keep more of your wealth and further balance out the effects of inflation.
Inflation & Insurance: By the Numbers
As mentioned above, a 30-year $1,000,000 term policy could be worth as little as $411,987 before it expires. Based on average rates from insurance companies, a 35-year-old male would pay about $800/year for coverage, or $24,000 over 30 years. Odds are he won’t die before his policy expires at age 65, and his beneficiaries will get nothing.
By comparison, a 35-year old male opting for a whole life insurance policy pays $30,000/year for coverage until age 65. At this point, his policy is paid-up—he doesn’t have to pay any more in premiums—but his coverage will last for the rest of his life. At age 65, his policy is guaranteed to have a death benefit of $2,557,830 and cash value of $1,466,189, which can be used tax-free for other investments. Adjusted for inflation, his death benefit has $1,053,792 in spending power and his cash value is worth $604,050.
Not a bad return, especially considering all the additional guaranteed benefits the man with whole life insurance receives. But what about the non-guaranteed returns on his policy?
Based on historic data, the man with whole life insurance would have a death benefit of $4,364,887 at age 65, and cash value of $2,083,794. Adjusted for inflation that’s $1,798,275 death benefit spending power and $858,495 cash value.
A Word on Policy Riders for Inflation
Policy riders are additional types of insurance you can add to a policy. They can be used for multiple types of insurance products. Some companies offer an Inflation Rider to help policy owners hedge against inflation. This type of rider is most commonly paired with long-term care insurance because rising healthcare costs tend to increase the most rapidly, compared to standard inflation rates. However, more and more companies are offering them in conjunction with term and whole life policies.
Perhaps a better rider to combat inflation within a life insurance policy is the Paid-Up Additions Rider. Available with whole life insurance, a Paid-Up Additions Rider allows you to contribute more to your policy, helping it grow more rapidly, increase in cash value, and earn more interest and dividends. Paid-Up Additions Riders are what set Wealth Maximization Accounts™ apart from traditional whole life, which has a reputation for slower growth.
Finally, a Guaranteed Insurability Rider allows you to increase your coverage in the future without having to take an additional medical exam or qualify in underwriting. This is a great rider to exercise if you think your insurance needs may change in the future.
Taking control of producing your money by generating wealth through your own Wealth Maximization Account will save you in times of inflation, hyperinflation, stagflation, and deflation.
The more capital in your control, the more opportunities there are to produce your own future. Using a whole life insurance policy to have gains, dividends, and cash flow offers you the best protection against inflation.
Listen: Inflation 101