When it comes to life insurance, everyone wants to get the protection they need for the most affordable price possible. As you may already know, life insurance policies are priced according to three major variables: how long you want the policy for, how much you want coverage for, and your personal health and lifestyle.
Calculating how much life insurance you need is relatively simple. There are five financial obligations, plus your current savings, that can help you decide how much coverage you need and for how long: college costs, childcare and other dependents, debt, end of life expenses, and a financial cushion for your family.
But as you can probably guess, these financial obligations don’t stay constant throughout your entire life. If you’re planning on getting life insurance for 30 years, for example, you know that at some point, your kids will actually go to college and you won’t need to factor in childcare costs, and you’ll have less debt (hopefully).
So why pay for coverage you don’t need? With the ladder strategy, you don’t have to.
How the ladder strategy for life insurance works
The ladder strategy is designed according to a pretty basic principle: as you get older, you need less life insurance coverage. Life insurance is designed to cover the financial risks of dying young, and as you get closer to retirement, as you finish paying off debt, and as your kids grow and leave home, that risk naturally decreases.
So it would make sense that your life insurance coverage decreases as well. But that’s not how life insurance typically works. Let’s say you get a 30-year, $500,000 term policy for $35 per month. You’re going to pay $35 monthly for the entirety of those 30 years, despite the fact that there’s a good chance you may not need the full $500,000 for the full 30 years.
The ladder strategy works around this by stacking, or "laddering," multiple life insurance policies on top of each other. Each life insurance policy ends at a different point, allowing you to effectively reduce your coverage over time while still locking in low rates while you’re young and healthy.
Here’s an example of one such strategy, put together by Pete, a 36-year-old male looking for $1,000,000 of coverage for 30 years. Below, we show you how the policies stack up, and how the price compares to a single 30-year policy:
Let’s break down exactly what we’re looking at here. First, let’s look at the single policy. For Pete, a typical, healthy, 36-year old male, $1,000,000 of life insurance coverage for 30 years would cost $75.91 per month. In total, Pete would spend $27,327.60 on this policy.
However, Pete doesn’t need $1,000,000 of coverage for the entire 30 years. He plans on aggressively saving for retirement and his kid’s college education, as well as paying off his mortgage within the next 25 years.
So instead of buying a single policy, Pete instead designs a ladder strategy with the help of his life insurance agent. Pete buys three separate policies:
A 30-year policy for $200,000
A 20-year policy for $300,000
A 10-year policy for $500,000
As you can see in the illustration above, Pete starts with a total of $1,000,000 in coverage. However, after 10 years, one of his policies expires and he is left with $500,000. This matches his financial plan of having less debt and more savings in 10 years’ time. After another 10 years – 20 years in total – Pete is left with just a single $200,000 policy that will help his wife pay off their remaining mortgage and complete her retirement savings, as well as giving her some additional money for funeral and living expenses.
The use of a ladder strategy has a radical effect on how much Pete is going to pay for life insurance over the next 30 years. Let’s look at what Pete’s total monthly bill is going to be for each 10-year period:
For the first 10-year period, Pete will be paying $53.01 for all three policies
For the second 10-year period, Pete will be paying $38.25 for two policies
For the third 10-year period, Pete will be paying $21.56 for one policy
As you can see, Pete is already saving money – instead of $75.91 for a single policy, Pete is just paying $53.01 for $1,000,000 of coverage (for the first 10 years). Why doesn’t it add up to $75.91? Because the bigger policies have shorter terms, he’s paying less for those policies than he would if they lasted for thirty years.
What will Pete pay in total? Just $13,538.40. Compared to a single 30-year policy, Pete is saving $13,789.20 – just over 50%.
We can’t promise that you’re going to save 50% if you choose a ladder strategy – however, as you can see from this illustration, building a ladder strategy is a very effective way to lower the cost of your life insurance over time. If you’re turned off by the price of your life insurance policy – for example, if you need a large amount of coverage or if you have health issues that are inflating the cost – a ladder strategy can be one of the best ways to reduce the amount you’re paying for coverage.
Are there any downsides to a ladder strategy for life insurance?
Ladder strategies are inherently more complicated than just buying a single policy. Not only do you need to shop for multiple policies, but you need to pay multiple bills, keep multiple sets of paperwork, and potentially keep multiple companies updated with new beneficiaries. If you do happen to die, it also means that your lawyer or whoever else is managing your estate needs to send multiple copies of your death certificate. If you’re an unorganized person, at least when it comes to your legacy plan, a ladder strategy could create problems down the line for your family.
You should note that there’s no long-term downside to buying your policies from different life insurance companies. However, it may compound the problems described above, and the application phase may take longer.
There is also the chance that your financial situation changes, and that your ladder strategy no longer matches up with what you thought your financial situation was going to be. A ladder strategy does give you some flexibility, however.
Let’s go back to Pete, for example. Let’s say that after 10 years, Pete decides that he actually still needs $700,000 of coverage. He can buy an additional $200,000 policy at that point. This policy will be more expensive for him than it would’ve been 10 years ago, but his combined bill will likely be more affordable than the original single policy we laid out for him.
How do I design my own ladder strategy for life insurance?
When designing your own ladder strategy, the most important thing to do is to get a grasp of how much coverage you’ll need at different points in your life. A financial planner will be able to help you do this. You can also just think about some of the major reasons you’re purchasing life insurance coverage – pay off mortgage, send kids to college – and think about what the status of those financial goals will be in 10 and 20 years’ time. (We suggest looking at 10 and 20 years because these are typical life insurance term lengths. Atypical term lengths may be available, depending on your life insurance company.)
You should also work with an independent life insurance agent who can help you shop and apply for multiple life insurance policies, potentially from multiple companies. While PolicyGenius’ online tool only lets you apply to one policy at a time, if you contact one of our life insurance agents, they can help you apply for multiple policies and even help you with designing your ladder strategy.