When you purchase a life insurance policy, you are essentially providing your surviving loved ones with a financial safety net that will help them move on without your income stream. Life insurance policies will typically fall into three basic types of coverage: term insurance (temporary), whole life (permanent) and universal life (can be temporary or permanent). But, you also have the ability to build a life insurance plan which is commonly known as an insurance ladder or laddering.
What is an Insurance Ladder?
Just like a traditional ladder has rungs, an insurance ladder has rungs of different types of insurance that enable you to reach a financial goal at a more affordable cost. In other words, you purchase multiple types of insurance products that will allow your investments to mature at different rates.
Take CDs for example, you can ladder your CDs so that they mature at different times. Instead of buying one CD for $5,000, you can invest that money in a series of CDs that will mature at different times like one year, three years, and five years. You then have the option of reinvesting that money into another series of CDs or into one five year CD.
How do Life Insurance Ladders Work?
A life insurance ladder is simply a strategy for buying the coverage you need at the most affordable rate and only keeping that coverage for a necessary period of time. For example, if you want to make certain your 15-year mortgage is paid off if you die, why would you spend the extra money to purchase that coverage for 30 years?
It sounds complicated but it really isn’t. In fact, many insurance professionals recommend laddering for applicants who cannot pay the premium for their entire insurance needs.
It’s a common understanding the head of household will experience a drop in his or her insurance needs over time and a common problem that he or she may not have the resources to purchase their entire face amount needs early in life, even though this is when the rates are the lowest.
A Simple Case Study
Let’s say John and his insurance agent have determined that based on his insurance needs analysis he needs $1 million in coverage now, but he and his agent expect those needs to diminish as time goes by because debts will have been reduced and the mortgage will be paid down substantially. Here is how John can ladder his coverage to save substantial money:
$1,000,000 Life Insurance Coverage
Ladder Strategy versus Single Policy
Total Lifetime Cost of Laddered Policies: $13,587.60
Total Lifetime Cost of Single Policy: $25,120.80
Total Lifetime Premium Savings: $11,533.20
So then, let’s drill down to what’s going on here. First, we’ll consider the single policy for $1 million in coverage. John is a 36-year old non-smoker and in good health. His 30-year term policy without all the bells and whistles would cost him $69.78 per month, which translates into $25,120.80 for the life of the policy.
But according to John, he does not need the $1 million in coverage over the entire 30 year period because he knows when his debts will be reduced and when his mortgage will be paid off. So rather than buying a single policy, it makes better financial sense to ladder his coverage so that the face amount of his total coverage is reduced during key periods in his life which, in his case, can be accomplished by laddering three policies with different face amounts and for different terms.
John and his agent decide on the following strategy:
These policy purchases line up with the time periods that John has determined his debts and mortgage would be paid and therefore he would need less coverage. Plus, the laddered policies will have a substantial effect on how much John has to pay in premiums over the next 30 years.
During the first 10 years of the ladder, John will be paying $53.10 per month for all three insurance policies.
During the second 10 years of the ladder, John will only be paying $38.42 for two of the insurance policies.
During the third 10 years of the ladder, John will only be paying $21.71 for the remaining insurance policy.
By laddering his coverage, John will save $11,533 because he will not be paying for coverage he doesn’t need.
What are the Downsides?
Ladder strategies certainly aren’t for everyone. Since multiple policies are involved there is a little more time and effort spent shopping for coverage and have multiple policies issued. As far as service is concerned, a good insurance professional will make sure that you understand how service tasks are multiplied but your agent should be more than happy to help you with things like beneficiary changes.
Yes, if you should die unexpectedly in the first 10 or twenty years, your executor, attorney, or beneficiary will need to file multiple claims and present multiple death certificates. When you consider these issues, the fact that you’re saving thousands of dollars on your life insurance should certainly remedy any additional aggravation.