What is a Term Insurance Ladder?

What is a term insurance ladder?

A term insurance ladder is quite simple. The purpose of “laddering” term insurance policies is to match up the life insurance coverage provided with the life insurance coverage needed so that you are only paying for what you need. For example, perhaps you need $1,000,000 of coverage for 10 years but only $500,000 for the 10 years after that. So you could buy a $500,000 10 year term policy and a $500,000 20 year term policy (instead of buying a $1 million 20 year term policy since you would be paying for more than you need).

Term insurance ladders are not a new or unique concept, and in this article we’ll go over instances why it can make sense to use them and show an example.

Example

For the example, we’ll use a 35 year old male who qualifies for the best rate. He has the following life insurance coverage needs: $1 million for 10 years, $500,000 for 20 years, and $250,000 for 30 years. The 10 year policy is going to cost $16 per month, the 20 year policy $15 per month, and the 30 year policy $24 per month, for a total of $55 per month. But is this the best deal? It turns out that for $56 per month he could purchase a $500,000 30 year policy and a $500,000 10 year policy ($40 and $16).

The reason he is able to get more coverage for the same price is because there are policy fees on each policy (so having two instead of three reduces costs) and lower expenses on larger policies (take a look at this article to read more about this: Two Tips When Buying Life Insurance).

This is more coverage than he needs (he has an extra $250,000 in years 20 through 30), but it is the same price. So, is it better for him to choose the second option? On the surface, it appears like it would be irrational not to. But, there are no free lunches. Although the initial price is the same per month, it will not be the same over the 30 years he plans to pay for coverage. Here’s a table that shows what his premiums and coverage would be like for each option.

Year Option 1 Premium Option 1 Coverage Option 2 Premium Option 2 Coverage
1-10 $55 $1,000,000 $56 $1,000,000
11-20 $39 $500,000 $40 $500,000
21-30 $24 $250,000 $40 $500,000

So for the first 20 years the two options are more or less the same. But in years 21-30, option 2 has a higher premium (for more coverage). Since he only wants to pay for what he needs, and assuming nothing changes over time, he’d be better off going with option 1.

What are the pros (and cons) of laddering?

Price savings: when you ladder your policies, typically you will be able to save money and only pay for what you need. There could be instances where it would cost more to ladder, depending on coverage amounts and length of policy terms, etc. But for the most part laddering is going to result in savings.

Coverage automatically reduces to reflect your needs: when you buy multiple of policies of various terms, the coverage will automatically expire at different points in time. If you only purchase one policy, it could be difficult or impossible to reduce the coverage to reflect your current needs.

Conversions: if the ability to convert to a permanent policy in the future is important to you, you will have slightly less ability to do so if you ladder. Typically term insurance policies with longer terms allow you to convert for a longer period of time. If you have multiple policies, the shorter term ones won’t give you as much time to convert. If you never plan to convert, then this is not a big deal.

Unexpected changes in the future: often coverage needs decrease over time (that’s what laddering is trying to account for), but sometimes they can go up (unexpected job promotion, child, larger house, etc.). If they do go up, then you could be underinsured at some point in the future, which is not a problem if you remain healthy enough to qualify for affordable coverage. If you aren’t totally sure about your future coverage needs, and it costs only a few more dollars to have a little extra insurance, it might be worth thinking about.

Conclusion

Laddering policies is often an effective way to save money and ensure you’re only paying for the coverage that you need. However, it is not necessarily always the best option. (Side note: regardless of the industry or product, whenever someone says that something is “always” the best, be very skeptical.) On our quotes page you can play around with different coverage amounts and term lengths (you don’t need to put in personal information to see prices).

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