How to use the ladder strategy to save on life insurance
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For most people, your need for life insurance changes as you get older, especially if you start a family. One disadvantage of life insurance is it gets more expensive as you age. With the ladder strategy, you get the maximum amount of life insurance you need over your lifetime at the best rates. Laddering life insurance means to buy multiple policies, usually term insurance, with different expiration dates, similar to buying certificates of deposit (CDs). Like auto insurance, the right life insurance strategy allows changes over time as your financial goals and needs change.
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Whole life insurance combines life insurance with an investment component.
- Coverage for life
- Tax-deferred savings benefit if premiums are paid
- 3 variations of permanent insurance: whole life, universal life and variable life include investment component
Term life insurance is precisely what the name implies: an insurance policy that is good for a specific term of time.
- Fixed premium over term
- No savings benefits
- Outliving policy or policy cancellation results in no money back
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- Using the ladder strategy, a healthy person can save quite a bit of money on life insurance over their lifetime.
- Someone with the same financial needs over time, like caring for a special needs child, may not be the best fit for the ladder strategy.
- If you expect your life insurance needs to decrease as you age, consider the life insurance ladder strategy.
What is the ladder strategy?
With ladder life insurance strategies, you purchase several term life insurance policies with varying term dates rather than one policy for all your needs. Why is this a good idea? The strategy takes advantage of the fact that your life insurance needs when you’re younger are typically more significant than they will be when you reach your senior years.
Varied term policies means that you can alter your coverage needs as your life circumstances — number of dependents living at home or outstanding loans or mortgages to account for — change over time.
How to ladder your life insurance
As an example, a 31-year-old married person with three children determines that now and for the next ten years at least, they need $1.5 million in coverage to provide for the family. After that, the mortgage will be paid off, so only $1 million is necessary for financial protection of dependents. In twenty years, the kids are out on their own, so needs are further reduced to around $500,000.
Your ladder might look like this:
- A 30 year policy for $500,000
- A 20 year policy for $500,000
- A 10 year policy for $500,000
If you should die in the first ten years, your death benefit will be a total of $1.5 million — covering all your family’s needs. If you die between 10 to 20 years, your death benefit from the remaining two policies will be $1 million. And if you die in the 20 to 30 year period, you’ll have a death benefit of $500,000 from your single remaining policy.
Consider how much life insurance coverage you need
Being able to ladder your policies requires you to have a good understanding of your current and future financial needs. If you are just starting your career, you may not need life insurance. But that changes for many people once they settle in with a spouse and children.
“After they get married, have kids and/or get a mortgage, suddenly there is somebody who would be in financial trouble if they died. So they need life insurance,” says Mike Piper, a certified public accountant in Manitou Springs, Colorado who is the author of several personal finance books and blogs at ObliviousInvestor.com.
To determine how much life insurance you need, you should write down all your debts owed, including future education costs for children and funeral costs. Consider things like how many years you want your income to be covered if you were to pass, especially if your spouse stays home to raise the kids. You can also use a calculator to help you decide how much life insurance to buy.
How you can save money with the ladder strategy
Laddering shorter-term policies not only is a good way to bulk up coverage during key times of your life, but it also saves on premiums, says Greg Sanders, founder of Peachtree Insurance Advisors in Marietta, Georgia.
The annual premiums on 20-year and 10-year policies would be lower than for a 30-year policy in the same dollar amount because coverage on the 10- and 20-year policies ends while the policyholder is younger and presumably in better health, he explains.
Using our example from before, a single $1.5 million policy might have an annual premium of $2,050 a year, while three staggered policies — each for $500,000 — might have the following premiums:
- 30 year policy: annual premium of $730
- 20 year policy: annual premium of $475
- 10 year policy: annual premium of $310
Those staggered policy premiums add up to $1,515, saving you $535 a year during the first ten years of coverage with a $1.5 million death benefit. (Actual rates for policies will vary from the examples provided here).
As your shorter policies expire, you would save even more because you would no longer be paying those premiums. You would also have less coverage, but in this case, you’re not paying for an excess of coverage either.
Who should use the life insurance strategy?
Although laddering your policies may be a good way to save money while ensuring that those you love are cared for, it’s not the best fit for everyone, especially if you are younger. “If you’re 27 years old and need $1 million worth of insurance, just buy a 30-year term policy,” says Sanders. “Don’t try to split it up. You might save a little bit of money, but the savings won’t be worth it.”
Laddering may also not be the best idea if you can’t forecast your financial needs in the decades ahead, which is true of many people. No one can be absolutely certain what their financial needs will be 10, 20 or 30 years down the road, and so there is an element of risk in laddering your policies that you may not be comfortable with.
If your financial needs will continue at their current rate, laddering may not be advantageous. If you have a child with special needs, for example, who will be unable to become financially independent, you’ll want to keep a robust insurance policy in force for future years.
Review how much life insurance coverage you need
It’s a good idea to go over your life insurance strategies regularly with a financial advisor. They may offer a perspective on your financial future that hasn’t occurred to you, and can save you from making expensive mistakes.
A laddering plan presumes that life insurance needs will shrink, but unexpected issues often arise — such as boomerang children returning to the nest, says Craig DeSanto, senior vice president in charge of life insurance for New York Life. “What they initially thought they would need ends up changing over time,” he says. “If you’re going to execute a strategy like this, it’s really important that you buy term insurance from a carrier that allows conversions to permanent insurance to give you the option to keep the policy in place if your needs have changed.”
Frequently asked questions
What is the best life insurance company?
The best life insurance company may be different for everyone and is based on your needs. Determine what is most important, like a company that allows you to convert term to permanent life insurance or a company with multiple policy options, and compare a few different companies to find the one that fits your needs the best.
What is the difference between whole life and term life?
Whole life insurance is a permanent policy that offers a level death benefit and premium over your lifetime. A term life insurance policy offers a level death benefit and premium, but only for a specific length of time, usually 10 to 40 years.
What is the best strategy when shopping for life insurance?
When shopping for life insurance, the best strategy includes deciding your coverage needs, picking the right life insurance policy type, researching companies and getting quotes. Once you have the right policy and company, fill out the application, prepare for the phone interview and exam and wait for approval.
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