What is a Life Insurance Ladder?

How to Save Money with the Life Insurance Ladder Technique

Read Time: 6 Minutes

Last week I wrote an article that highlighted 7 ways to save money on life insurance. It is filled with great, easy tips to prevent you from buying more insurance than you need, and to save you money on the insurance you do need.

This week I wanted to cover an 8th, more advanced way to save money on life insurance. It’s called “life insurance laddering” and is so cool it deserved its own article. It’s also a little more complicated, and thus I needed a whole article to fully explain it.

We’ll use an example to walk through the exact problem that laddering solves, how much money it could save, and some tips you should consider before building your own life insurance ladder. Let’s get to it.

Andrew the Architect Needs Life Insurance

1st, let’s walk through a hypothetical of somebody who is looking to buy life insurance.

His name is Andrew the Architect and he is 30 years old. Andrew and his wife just had a baby and thus, Andrew wants to buy life insurance to make sure his wife and child are taken care of if Andrew suddenly passed away. He wants the insurance to last for 20 years, at which point their child will be out of the house and on his own.

Andrew’s salary is $100,000 per year. To keep this example simple, let’s ignore inflation and taxes. So if Andrew wants enough life insurance to replace the next 20 years of income, he needs a total of $2 million of insurance (20 years x $100,000/year = $2 million). Again, to keep things simple, let’s ignore the time value of money and discounting for now.

Normally, Andrew would take this information and go buy a 20-year term life insurance policy for $2 million and call it a day. Using Policygenius to get a quote, a healthy 30-year old male might pay around $70/month for that policy, or $840/year.

Policygenius Screenshot
Policygenius lets you see prices from multiple companies all at once.

That all seems reasonable enough. In fact, this is similar to how most Americans purchase their life insurance. But let’s take a look at the problem with what Andrew just did.

Problem: Insurance Needs Shrink Over Time

For most people, your life insurance need decreases as you get older. That’s because the longer you live, the fewer years of income you need to replace. But with a term policy, the amount of insurance you get stays flat. This means as time goes on, you will get more and more “over-insured.”

If Andrew got hit by a bus today, his family would need the full $2 million to replace the next 20 years of his income. But what if Andrew lives 1 more year, and then gets hit by a bus? Then the total lost income is only $1.9 million. 2 years from now only $1.8 million. For Andrew his insurance needs looks like this.

Life Insurance Need Graph

His insurance need steadily decreases, yet his total insurance stays flat, leading to over-insurance. And being over-insured usually means spending more money than you need to.

Solution: Build a Life Insurance Ladder

The solution is actually pretty easy to understand, and only slightly more difficult to implement. In my opinion, it is well worth the time. Not to mention it can save you some money.

Instead of buying 1 large term policy, you stack multiple, smaller term policies on top of each other. And you have these term policies last for varying lengths of time. Continuing our example with Andrew, his life insurance ladder may look something like this:

  • 20-year term policy for $500,000
  • 15-year term policy for $500,000
  • 10-year term policy for $1,000,000

His total current amount of insurance is still the full $2 million that he needs today. But as Andrew gets older, some of his policies will expire, thus decreasing his total insurance amount to keep pace with his decreasing insurance need. Here’s that same graph from above, but with an insurance ladder instead of 1 large term policy.

Life Insurance Need Graph

In theory, Andrew could buy 20 different policies and have them fall off each year. However in practice, most term insurance policies come in increments of 5 years, and many do not go shorter than a 10-year policy. Plus, one should always do a cost/benefit analysis before getting too complicated with their finances. In my opinion, this is a situation where increments of 5 or 10 years will suit most people just fine.

Hypothetical Cost Savings

A huge benefit of building a life insurance ladder is the potential amount of money you could save by not over-insuring yourself.

I ran some quotes on Policygenius for a hypothetical 30-year old, healthy male living in NYC. I used quotes from the same insurance company (BannerLife) to keep it apples-to-apples. Building a life insurance ladder could save Andrew an estimated $4,540.80 over the next 20 years!

Lifetime Cost of Life Insurance
Monthly premiums shown are from Policygenius and are only quotes. Actual premiums will vary.

Of course, your exact savings will depend on your personal situation. The main cause of the savings is that you are only paying for insurance you truly need, at the time you need it. When Andrew is 45, he is only paying for $500,000 of insurance instead of $2 million. And that savings adds up fast.

Wrapping It All Up

We all know the benefit of having life insurance, but that doesn’t mean we enjoy paying for it. That is especially true when you are paying for more insurance than you need in the 1st place, which happens all too often. Building a life insurance ladder solve this exact problem.

It takes a little planning to set up properly, but that planning could save you thousands of dollars over your life. Another potential benefit we didn’t discuss is diversification. Some people prefer to buy policies from 2-3 different insurance companies, just in case one goes bankrupt.

All in all, there are many potential benefits to building a life insurance ladder. From building a more personalized plan, to saving money, to diversifying your insurance companies. Anybody who is looking for life insurance should consider this strategy before buying a policy.

The conclusions drawn throughout this website are not advice meeting the particular investment needs of any investor, and they are not intended to serve as the basis for financial planning, tax, or investment decisions. This website is for informational purposes only and is not a solicitation or an offer to buy any product, service, security or instrument. The opinions expressed throughout this website are my own and not those of any company I work for.