When you think of laddering financial products, what usually comes to mind is bonds or CD’s, not life insurance. Laddering is a strategy whereby the investor purchases financial products with different maturity dates. In the case of bonds or CDs, staggering maturity dates reduces the risk of reinvesting money at low interest rates.
In this article, we will look at how you can ladder life insurance products to save money and ensure adequate protection. Laddering life insurance policies mean buying life insurance with different term periods. Since the need for life insurance usually diminishes as your savings (and kids) grow, it can make sense to “step down” your total amount of coverage over time.
An Example of Laddering for a 45 Year-old
Below is an example of laddering for a 45 year-old male qualifying for the Preferred Best Non-tobacco rate. This 45 year-old (we’ll name Tim) has two kids in their mid-teens. This type of laddering works well for someone with a stable income and predictable financial obligations.
Let’s say that Tim knows the remainder of his mortgage will be paid off in 5 years and that college costs for his kids will be paid off in 10 years. The total amount of coverage is based (roughly) on these two financial commitments plus income replacement. The amount of life insurance can be structured in such a way as to step down coverage with three different term products.
|Total Premium for the first 10 years: $15,760||Total Premium for the next 5 years: $5,155||Total Premium for the last 5 years: $2,640|
The cumulative premium would be $23,555 over 20 years using the laddering technique.
The cumulative premium for a 20-year level term would be $2106/year X 20 years = $42,120
$18,565 premium savings was realized by laddering. Clearly, this type of laddering would result in significant savings for Tim and would allow him to invest more in his retirement accounts.
When Laddering Term Policies Is Not Always The Best Idea
For people under the age of 35 (approximately), it usually makes more sense to buy a longer term policy than split it up into two or three policies. The savings realized by laddering would be relatively low. Let’s look at an example where a 30 year-old female named Sarah is shopping for a 30 year term policy for $1 million (at Preferred Non-tobacco rates).
- One Policy: $1 million 30-year term policy is $670/year
- Two Polices (Laddering):
- $250,000 30-year term policy is $338/year
- $750,000 20-year term policy is $235/year
In the example above, Sarah would save approximately $1000 over the course of 30 years by laddering. However, by keeping the 30-year term, she has an extra $750,000 of coverage for 10 more years. This could be well worth the additional premium cost of $100 per year. In this situation, we would recommend the straight term policy. Of course, we recommend revisiting this every few years since needs often change over time.
“Naturally Occurring” Life Insurance Ladders
Sometimes, we ladder our life policies unintentionally. You might purchase a $500,000 20-year term policy when your first child is born. Two to five years later after child #2, you realize you need to step up your coverage. So, you purchase another $500,000 20-year term policy. Well, that put a ladder in place that could effectively cover your needs. Again, this assumes your children become independent in their early to mid-20s and no other major health, career, or financial setbacks occur. We’ll look at that next…
Laddering Term and Permanent Life Policies
Since life has a way of taking unexpected turns, it is a good idea to protect against these risks with life insurance. With Tim’s example, everything looks great on paper, but if something happens unexpectedly, then the need for life insurance could go beyond age 65. Setbacks such as illness, job loss or other financial issues could cause you to need life insurance beyond the anticipated time period.
Sometimes, it makes sense to ladder term and permanent policies. Some people don’t like the idea of dropping down to zero life insurance overnight. You could keep a small portion of your total coverage in permanent life insurance. For those who want to keep their life insurance and investments or savings separate, then a guaranteed universal life insurance policy (term to age 100) could work well.
Guaranteed universal life policies are not designed to build cash value, but simply provide life insurance guaranteed to age 100. The guarantee age can vary from age 90 to 121. Most carriers allow you to lock in your desired guarantee age.
The purchase of a second home or having a “boomerang child” could be reasons to keep coverage longer. Also, you might simply want to leave an inheritance to loved ones with life insurance. There are numerous reasons why you might want to keep some life insurance in force beyond 20 or 30 years. Some people “earmark” a permanent life insurance policy for final expense needs. There are carriers that will allow smaller face amounts, so a permanent policy could be as low as $25,000 to $50,000.
Because we can’t predict the future, it can be a good safety measure to ensure your term policy is convertible. This provision allows you to convert your term policy to a permanent policy without any evidence of insurability. This means that if you develop a very serious disease (or even a terminal disease), you can still convert to a permanent policy at the same underwriting class for which you originally approved. The rate will be higher due to your attained age. Also, permanent life insurance is more expensive since your beneficiaries will receive the tax-free death benefit.
Some term policies will allow you to convert your term policy to permanent coverage. These conversion privilges vary among carriers, so it is an important factor to consider when shopping for a policy. Some term products only allow conversion during the first five to ten years of the policy. Other term products allow conversion at any time, to any of the company’s permanent products.
Laddering life insurance policies can be an excellent way to secure needed protection and save money. It’s not always the best (or desired) option, but it’s good to be aware of this strategy. Many agents won’t mention it because it takes more work on their part to prepare quotes and submit more than one application. So, if this option isn’t suggested to you, be sure to ask about it.
When shopping for life insurance, we suggest working with an independent agent who has at least 10 years of experience. An independent agent has the ability to shop the market and compare rates with over 50 companies. A lot of the large online agencies are independent agencies, but they only offer 12 or 15 companies. It also takes many years of experience to properly advise clients and help them structure policies correctly.