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Life Insurance Laddering – What It Is & Why It Makes Financial Sense

Term life insurance provides financial protection and peace of mind for the policyholder’s loved ones in the event of their untimely death.

For many young and middle-aged policyholders, their policy’s death benefit is significantly higher than the value of their liquid savings. That allows their chosen beneficiaries — most often a surviving spouse or children — to replace years of income lost to their death and settle any debts they’ve left behind without impacting the survivors’ long-term financial plan.

In absolute terms, term life insurance from insurers like Haven Life isn’t inordinately expensive. A healthy nonsmoker in their 30s generally pays less than $100 per month for each $1 million in coverage on a 20-year term and less than $200 per month for each $1 million in coverage on a 30-year term, assuming they consent to medical underwriting. (No-exam policies tend to be more expensive.) Policyholders who purchase life insurance in their 20s typically pay even less.

Life Insurance Ladders: Costs and Benefits of a Ladder Strategy

On the bright side, policyholders don’t pay premiums forever. By the time they’re within sight of retirement, many have enough capital saved to cover any remaining debts, future financial obligations, and living costs, rendering continued life insurance coverage unnecessary. That’s the beauty of term life insurance — you only pay for it as long as you need it.

On the not-so-bright side, life insurance coverage costs increase steeply with term length, especially for older policyholders and those with health issues. The cost difference between a 20-year term policy and a 30-year term policy can be dramatic.

That’s where the concept of life insurance laddering comes in. A life insurance ladder features multiple policies, each with its own term and death benefit, in place of a single longer-term policy with a higher death benefit. The ladder works best when the policies’ cumulative death benefit is equal to that of the single policy it replaces and when its longest-term policy’s term length matches the single policy’s. Because its longest-term policy has a smaller death benefit than the single policy the ladder replaces, the ladder’s cumulative premium should be lower — sometimes significantly lower — than that single policy’s.

The promise of a lower premium isn’t the only reason to build a life insurance ladder strategy in place of a single policy. Once you’re through with the comparatively complex setup process, laddering offers greater logistical clarity, flexibility, and coverage proportional to your needs than a single policy that disappears all at once.

Anyone with multiple major debts and expected future expenses can most likely benefit from a life insurance ladder that endures until those debts and expenses are satisfied.

And life insurance laddering has clear-cut benefits for most would-be policyholders. But it’s not appropriate for those with straightforward life insurance needs or those in a life stage of life during which it’s impossible to project future financial needs. That caveat most often applies to younger unattached applicants uncertain about whether they plan to get married, buy houses, have kids, go back to school for an advanced degree, or make any other life decisions with drastic financial consequences.

Benefits of Laddering Life Insurance Coverage

A multipolicy life insurance ladder can lower costs and increase flexibility. Specifically, the benefits include:

Getting the Same Cumulative Death Benefit at a Lower Cumulative Premium

The actual change in premium depends on several specific factors, including the policyholder’s age and health status, policy term, and total death benefit. But the cumulative premium for a life insurance ladder is often lower — perhaps significantly so — than the premium for a single long-term policy of equivalent size. That’s because laddering reduces the amount of coverage paid for when the policyholder is older and more likely to die — and therefore more expensive to insure.

Assigning a Purpose to Each Life Insurance Policy

A multipolicy ladder makes it easier to stay on top of multiple life insurance needs. If you’re applying for life insurance to protect your heirs from more than one significant financial burden — for example, not just the outstanding balance on your mortgage, but your student loan debt and kids’ expected higher education expenses too — it only makes sense to associate a specific policy with each.

A 10-year term policy for the current balance due on your student loans is appropriate if you have eight years until payoff, just as a 20-year term policy for the current balance due on your mortgage fits a home loan with 17 years remaining.

Offsetting debts on a one-to-one basis isn’t the only reason for life insurance coverage and is unlikely to provide adequate financial protection for your family if you die prematurely. Nonetheless, it’s a useful frame for organizing at least a portion of your life insurance needs.

Paying for Less Excess Coverage

The typical policyholder’s life insurance needs generally decrease over time as they pay off debts, mark major life milestones, and realize increasingly higher shares of their potential lifetime earnings. So they’re not likely to need as much coverage in the 25th year of a 30-year term as in the fifth.

Because laddered coverage steps down over time, a thoughtfully constructed ladder limits the amount of unnecessary coverage the policyholder pays for at any given time. What they do with the savings is up to them. For example, you can use the snowflake method to pay down debt or up contributions to tax-advantaged retirement accounts.

Mitigating the Cost of an Underlying Health Condition or Habit

All other factors being equal, policyholders with unhealthy habits (tobacco use in particular) or underlying health conditions generally pay more for the same amount of life insurance coverage.

In dollar terms, the difference in monthly premiums paid by healthy nonsmokers and tobacco users or those with health issues rises in proportion to the death benefit. If your life insurance needs are substantial — say, $2 million or more — you’re looking at an uncomfortably high premium over your healthier peers.

While laddering can’t wholly eliminate what’s effectively a tax on your ill health or poor habits, it does reduce coverage toward the end of the term, when you’re statistically more likely to succumb.

Preserving Flexibility

A life insurance ladder doesn’t preclude you from adding more life insurance at a later date if you need to. That can happen because you decide to start a business later in life and take out key person insurance to protect your business partner’s interest in the event of your death or because you or your spouse decide to stop working full time to focus on child-rearing.

When to Wait on Your Life Insurance Ladder

For policyholders with substantial life insurance needs, laddering multiple policies is usually the way to go from a financial and logistical perspective.

But not always. Several circumstances indicate laddering might not be the best option — at the moment or ever. For example:

You Don’t Have Kids and Are Quite Certain You Won’t in the Future

One of the most pervasive myths about life insurance is that it’s not necessary for policyholders without children and no plans to reproduce or adopt. Though they might not need as much as a parent of four, unencumbered policyholders often do need life insurance to ensure their sudden absence doesn’t burden their loved ones.

For example, if you jointly own a home with a spouse or domestic partner who’d struggle to carry the mortgage on one income, a single term policy with a benefit enough to pay it off could be what keeps them in the house after you’re gone. But that doesn’t necessarily mean you need to ladder depending on your other expenses.

You’re Determined to Keep Your Expenses Low Throughout Your Life

If you’re determined to live frugally until you achieve financial independence or retire, your life insurance needs are more likely to be minimal.

A single medium-term life insurance policy plus disability insurance coverage that kicks in if an illness or injury hampers your long-term income potential could be enough to cover your bases.

You’re Really Not Sure How Much Coverage You’ll Need in 20 or 30 Years

Calculating one’s life insurance needs is not an exact science — if only because we can’t know for sure what the future will bring.

However, some would-be policyholders know even less about their future: whether they’ll have a family, buy a house, go back to school, or find themselves footing years of medical and long-term care bills for an ailing parent.

For these folks, choosing a life insurance ladder over a single, longer-term policy could be overkill, especially earlier in life. It might not be the optimal move in purely financial terms. But if you have more questions than answers, nab a modest 20- or 30-year policy in your 20s or early 30s, and leave the option to add coverage later, possibly in ladder form.

How to Build a Life Insurance Ladder

Building a life insurance ladder requires a bit more effort than initiating a single life insurance policy, but it’s not a monumental task.

Calculating Your Life Insurance Needs

Begin by calculating your projected expenses, income, and net worth over the next 30 years (or the maximum duration you expect to need life insurance coverage, if less than 30 years). Each variable affects your life insurance needs at different stages of life.

Projected Expenses

In theory, this is as simple as multiplying your current annual household spending by an annual cost of living increase factor (accounting for inflation — say, 3% per year) and the total number of years in your projection.

In practice, this calculation is highly inexact, especially in the project’s later years, and your life insurance coverage probably doesn’t need to offset every cent you expect to spend over the next 30 years anyway.

A simplified alternative involves adding up all the major expenses you’d like your ladder to cover.

Think mortgage and student loan balances, outstanding credit card or personal loan debts, higher education expenses for your kids, and perhaps even longer-term outlays like your kids’ weddings. If your kids are young, you should also calculate child care expenses so your spouse can work full time.

To be sure, certain future expense projections do need to account for inflation. For example, it’s an easy bet that university tuition and weddings will both cost more by the time your kids are ready for either.

Projected Income

Like your expense projections, this isn’t an exact science. The simplest way to do it is to multiply your current income by the average annual raise you expect to receive — say, again, 3%.

That assumes you stay on the same career track, receive steady raises, and don’t significantly change your income trajectory to the upside or downside. None of these are sure bets, of course, especially as you move farther into your projection.

Projected Liquid Net Worth

If you stick to your long-term financial plan, you should eventually have adequate liquid assets to settle any remaining debts and expenses while continuing to provide for your surviving family members’ needs (including retirement income).

This capacity is a function of both your surviving family members’ expected living costs after your death and your liquid net worth (the value of easily liquidated assets, such as cash savings and taxable securities).

Your net worth, in turn, is a function of your savings rate over time and the long-term rate of growth of your savings and investments. Though long-term stock market returns generally range from 7% to 12%, depending on who you ask, your actual rate of return depends on factors like asset allocation, withdrawals, and market timing.

Determining How Much Life Insurance You Need & Building Your Ladder

Your life insurance needs depend on what you’d like to cover. Are you interested in covering only the major expenses that could burden your survivors or in replacing all the income lost to your premature death?

Laddering is appropriate in either scenario. But the size and structure of your ladder depend on which you choose.

Prop tip: Ladder, an online term life insurance provider, has a useful calculator on their website to help you determine exactly how much coverage you need.

Covering Expenses

Generally, a life insurance ladder built to cover expenses requires less coverage overall than one built to replace income while covering long-term expenses.

Consider this theoretical expense-oriented ladder that includes single-purpose policies covering specific life expenses:

  • A $500,000 policy with a 30-year term to cover the inflation-adjusted cost of private higher education expenses for two children (one a toddler and one yet to be added to the family)
  • A $250,000 policy with a 20-year term to cover the balance due on a $400,000, 30-year mortgage with 18 years left in its term
  • A $400,000 policy with a 10-year term to cover the inflation-adjusted cost of full-time child care for two younger children

This ladder replaces a single 30-year policy with a $1.15 million death benefit. During the first 10 years, the cumulative death benefit is $1.15 million: the sum total of benefits on the 30-, 20-, and 10-year policies.

From the 10th to 20th year, the cumulative death benefit steps down to $750,000 after the 10-year policy expires. And from the 20th to 30th year, the death benefit reduces to $500,000.

Replacing Income

If income replacement is your goal, expect your ladder to have a higher total death benefit than your expense-only ladder. Certainly think about replacing the income your family loses to your premature death.

But also think about any income lost due to changes in your spouse’s working life after your death — for instance, stepping down to part-time status to be present for young children.

Despite the greater need, an income-replacement ladder follows the same principle as an expense-only ladder: decreasing needs over time. In this simplified hypothetical scenario, let’s say you’re a 35-year-old who expects total inflation-adjusted earnings of $3 million over the next 30 years, after which you plan to retire.

Early on in your ladder’s existence, you must replace close to $3 million in lost earnings. But your coverage needs decrease with each passing year as you convert potential income into banked earnings.

In theory, by the last year of your ladder’s 30-year term, you’ll need to replace just $100,000 (or less) in potential earnings — though your actual earnings will probably be higher in real terms during the last year of your career.

In this scenario, your ladder can be pretty simple:

  • A $1 million policy with a 30-year term
  • A $1 million policy with a 20-year term
  • A $1 million policy with a 10-year term

You could also split the 20-year policy into 15- and 20-year policies valued at $500,000 each, slightly reducing the net cost of coverage between the 10th and 20th year (since a 20-year policy costs more than a comparable 15-year policy).

Do whatever works for your budget and your family’s needs.

Shopping Around

Finally, when you’re ready to apply for life insurance, take your time shopping around. Competition is fierce in the life insurance industry, and no matter your net worth or health status, rest assured the top life insurance companies want your business.

Even if the best available offer costs just $10 less per month than the most expensive, the savings add up: $120 per year and $1,200 over 10 years — over and above whatever the savings you’ve already banked by choosing to ladder in the first place.

Companies like PolicyGenius will provide you with multiple quotes in just minutes, making the process much easier.

Final Word

Most of the time, laddering multiple term life insurance policies makes financial sense. In lieu of a single long-term policy that provides a flat death benefit until its term expires, you get multiple (often three) policies with variable term lengths, a cumulative death benefit equivalent to the single policy it replaces, and a comparatively low cumulative premium.

Precisely how much you can save with your ladder depends on a constellation of factors, including your age, health status, and desired death benefit. But it’s safe to bet on a 30-year ladder being cheaper than a 30-year policy with the same death benefit.

Laddering isn’t appropriate for every policyholder, however. Before making any significant financial decision, consult a financial advisor about your would-be ladder’s suitability in your specific situation. Taking an extra few days to make the right call can save you a great deal in the long run.

Brian Martucci writes about credit cards, banking, insurance, travel, and more. When he's not investigating time- and money-saving strategies for Money Crashers readers, you can find him exploring his favorite trails or sampling a new cuisine. Reach him on Twitter @Brian_Martucci.

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