When planning your retirement, it’s important to consider how inflation and a rising cost of living may impact your purchasing power. If you have a life insurance policy, you might decide to add a cost-of-living rider as a potential hedge against inflation. This type of rider can also be added to an annuity contract as well. But is it right for you? Understanding how a cost-of-living rider for life insurance works can help you to decide. SmartAsset’s free matching tool can connect you to a financial advisor who can help you sort through your life insurance options.
What Is a Cost-of-Living Rider for Life Insurance?
Generally speaking, riders are additions to a life insurance policy that are designed to expand or enhance your coverage. A cost-of-living rider for life insurance is a rider that allows your policy to increase in value over time to keep pace with rising inflation. This means that once you pass away, your beneficiaries receive a larger death benefit from the policy.
The purpose of this type of rider is to help offset some of the impacts inflation and rising prices can have on the policy’s value. Without this type of rider, the death benefit payable to your beneficiaries may yield much less purchasing power over time. This is the result of inflation degrading the policy’s value.
How a Cost-of-Living Rider for Life Insurance Works
Cost-of-living riders work by allowing you to increase your policy’s death benefit over time to track increases in inflation. As with other riders, adding this type of rider can increase your policy premium. Typically, this is a small increase rather than a large one.
A cost-of-living rider may only be offered with certain types of life insurance policies. For example, you may only be able to add this on to a standalone accidental death benefit policy, rather than a more traditional term life or permanent life insurance policy.
If you have a policy that includes a cost-of-living rider, the policy’s death benefit can increase incrementally over time. The amount of the increase and the frequency with which increases are applied can be determined by the policy terms.
So for example, your policy might increase in value by 3% to 6% of its original face value every five years. Your life insurance company may set a cap on the total increase that’s allowed. For example, the maximum increase may be 25% or 30% of the policy’s original face value.
The insurance company may establish a set percentage rate for increases or use a financial index to determine how to set the increase schedule. For example, your insurer may use the consumer price index (CPI), which measures changes in the price of different consumer goods and services. This is a standard measure of inflation.
Whether you need to take a medical exam in order to add a cost-of-living rider can depend on the type of policy you have. With accidental death benefit policies, for example, a medical exam may not be necessary. But permanent policies typically do require a health exam or medical screening to qualify.
Benefits of a Cost-of-Living Rider for Life Insurance
The main benefit of adding a cost-of-living rider to a life insurance policy is the ability to hedge against inflation. When prices rise, your dollars don’t go as far. A cost-of-living rider can ensure that your beneficiaries are able to retain some purchasing power from the policy’s associated death benefit once you pass away. There are some considerations, however. Again, you’ll likely pay a little more for life insurance premiums by adding a cost-of-living rider. The cost may be negligible, however, when compared to what you might pay to add a second life insurance policy.
It’s also important to keep in mind that cost-of-living riders may only be available with certain types of life insurance. Talking to a trusted insurance agent or a financial advisor can help you determine which kind of life insurance you’ll need in order to add on a cost-of-living rider.
Finally, cost-of-living riders won’t necessarily fully offset the impacts of inflation. If the rate of inflation outpaces the rate at which your policy’s face value increases, this can still erode the purchasing power of the death benefit you leave behind.
Who Needs a Cost-of-Living Rider?
A cost-of-living rider may be something to consider if you’re worried about how changing inflation may affect your policy’s death benefit. If you’re married and the primary breadwinner, for example, you may want to have this type of rider in your policy to ensure that your spouse can enjoy a comfortable retirement after you pass away.
You may not need a cost-of-living rider for life insurance, on the other hand, if you’re diversifying your investments in ways that are designed to minimize the impacts of inflation. Real estate, for example, is typically considered an inflationary hedge because of its low correlation to the stock market. Landlords who own rental properties can raise rental rates over time to keep up with rising inflation.
Incorporating dividend-paying stocks or fixed-income products like bonds can also help to create a buffer against inflation. Dividends represent a share of a company’s profits that are paid out to shareholders. You can use them for current income if needed or reinvest them to buy additional shares of the same stock.
Bonds can also provide steady income with less risk exposure than stocks. Treasury Inflation-Protected Securities or TIPS have a built-in buffer against changing prices, as the principal increases with inflation and decreases with deflation, as measured by the CPI. Having a mix of inflation hedges in your portfolio may eliminate the need to add a cost-of-living of rider to a life insurance policy.
Cost-of-Living Rider for Annuities
An annuity is an insurance contract in which you pay premiums to the annuity company, then receive regular payments at a later date. An immediate annuity typically starts payments within a year while a deferred annuity allows you to wait several years to begin receiving payments. Annuities are attractive for creating a guaranteed stream of income for retirement. If you have an annuity or are considering purchasing one, you may be able to add a cost-of-living adjustment rider which works similar to a cost-of-living rider for life insurance.
With this type of rider, your annuity payments would adjust each year in order to allow you to keep up with inflation. The initial benefit you receive may be reduced and the cost-of-living adjustment you receive may be based on that lower amount.
Just like with life insurance, the annuity company can apply increases to your payments as a flat percentage or they may base increases on changes to the consumer price index. The same pros and cons that apply with a cost-of-living insurance rider apply with a cost-of-living annuity rider.
The Bottom Line
Adding a cost-of-living rider to your insurance policy, or any rider for that matter, can make the policy more valuable. But before adding riders, consider what you’ll pay and how much you’ll benefit from making those additions. Also, it’s helpful to look at your entire financial plan to see whether it’s really something you need.
Retirement Planning Tips
- Consider talking to a financial advisor about whether a cost-of-living rider for life insurance or an annuity is something you might need. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- An annuity can help you to create guaranteed income in retirement but there are some important things to consider before purchasing one. For instance, it’s helpful to know what fees you might pay as annuities can have a variety of charges. Also, consider how annuity income can affect your tax situation as qualified annuities are considered taxable income. Finally, do your research on annuity companies to find one that’s reputable and has good credit ratings.
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