How to use the ladder strategy to save on life insurance

People who invest in certificates of deposit (CD’s) are demonstrating the concept of “laddering.” They buy CDs that mature on different dates to avoid being locked out of their cash or locked into a low interest rate for too long.

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An older couple sits with a young woman who is a financial specialist. She is reviewing their options.

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You can build a similar ladder with life insurance, planning extra coverage for when you’ll need it the most and tapering off coverage when your needs won’t be as great. This approach can save you money.

You can ladder life insurance two ways:

• Buy policies with different term lengths at the same time: for example, one policy with a 30-year term, one with a 20-year term and one with a 10-year term.
• Buy one policy now and additional policies later. You might buy a 30-year policy early in your career or marriage and ladder on a 10- and/or 20-year policy during your peak earning and debt years, after you have children, buy a house or incur other financial obligations.

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.

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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.

Later, that need for life insurance should decrease as your savings grow, your debt balances shrink and children leave the nest. By reducing the amount of life insurance during that stage of life, a policyholder could save hundreds of dollars a year in premiums, Piper says.

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, a mortgage refinance that increases housing debt or the purchase of a second home, 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.”

Converting to permanent insurance – such as a whole life policy – may be a better choice for some to account for the uncertainties of the future. Another strategy is ensuring that your term policy lets you decrease your death benefit if it becomes clear that you don’t need as much insurance as you’re carrying. This will allow for savings on your premiums, provided you are on board for a lower payout.

In short, laddering your policies is a good strategy if you are confident that the financial needs of your beneficiaries will decrease over time. If you have doubts about this, you may be better served with a single large term or permanent policy.

Don’t forget your policies

Let your heirs know about your life insurance ladder: how many policies you have and with what companies. “It’s important that they know all of the policies you have in place,” Piper says.

Finally, don’t forget you have more than one policy when it comes time to pay the bills on them. “You wouldn’t want to let one policy accidentally lapse by missing a premium payment thinking, for instance, that you already paid the life insurance bill last month,” he says.