The Pros And Cons Of Term Life Insurance Ladders

One of the most common questions among physicians who are considering purchasing term life insurance is how much life insurance do you need to buy?

In general, you should buy as much life insurance as you need. However, your insurance needs are not fixed over your lifetime. Therefore, a term life insurance ladder may be appropriate to meet your changing insurance needs.

Term Life Insurance Needs By Age

In general, we need the most term life insurance at the start of our careers. We haven’t built any net worth, but our families have frequently structured their lives based on our future incomes. Therefore, if we were to die prematurely, we often would like to be able to replace what our future careers would have yielded.

In addition, at a young age, your heirs will have the most future financial needs. The kids will need to be raised and college will need to be saved for. Your spouse may need additional money to supplement his or her income.

However, as you get older, term life insurance needs decline. You have built a substantial retirement nest egg on your own. Many fixed costs, such as your house or college savings, have also been paid off. By the time you are 50, it is possible that you have paid off your house and have college fully funded, and you are halfway to saving for retirement. You certainly don’t need as much money when you retire than when you were a resident.

The Term Insurance Ladder

One common strategy to address the fact that your insurance needs change over time is to use a term insurance ladder.

Each individual life insurance policy has a fixed benefit and a fixed premium that you have to pay over the life of the policy. For example, a 30-year policy would give benefits over a 30 year period.

So one way to structure a term life insurance ladder would be to purchase a $1 million dollar 10-year policy, a $1 million dollar 20-year policy, and a $1 million dollar 30-year policy. With this term life insurance ladder, you would receive $3 million if you die in years 1-10, $2 million if you die in years 11-20, and $1 million if you die in years 21-30. Hopefully, you are accumulating money for retirement and other expenses as you get older and your life insurance needs decline.

This would be cheaper than paying for $3 million of 30-year life insurance. Since you are more likely to die in your 50s than in your 30s, the last 10 years of the life insurance policy is the most expensive, which raises the premium. By buying less insurance for your 40s and 50s, you lower the total cost of your insurance. Of course, you are still buying life insurance, but you should only buy the amount of life insurance you need, which is what is happening here.

Downsides of the Term Insurance Ladder

More Fees

Because you have to generate three different life insurance policies, a ladder with three $1 million fees will cost more than paying for a single $3 million policy. Put simply, the costs to create a life insurance policy are fixed, and then the costs to give you more life insurance is simply a multiplier of the benefit amount.

For example, a $1 million policy might cost $250 a year, $50 of which is the fixed cost of creating the policy and $200 of which is hedging against the actual risk of death. A $2 million policy might cost $450 a year, $50 of which is the fixed cost of creating the policy and $400 of which is hedging against the actual risk of death. A $3 million policy might cost $650/year.

However, if you purchase a term life insurance ladder, you have to pay that $50 fixed cost three times. So from an expected value standpoint, you are paying more to the insurance policy in profit margin by doing the term life insurance ladder. However, life insurance, in general, is a negative expected value proposition, but we still strongly recommend it because the peace of mind of having your family taken care of financially if you die prematurely is worth the extra cost. Similarly, if you can structure your life insurance policy in a way that more accurately fits your life insurance needs, than paying a little bit extra in fees might be worth it.

Don’t Forget Inflation

Remember that both the benefit and the premium are not indexed to inflation. A $1 million dollar 30-year term life insurance policy purchased when you are 30 will still pay out $1 million dollars if you were to die at age 59. However, the value of $1 million dollars in 29 years is probably only worth $500,000 in today’s dollars. So inflation naturally degrades the value of your insurance policy.  In this sense, it may not be completely necessary to build a term life insurance ladder.

Conclusion

A term life insurance ladder might make sense for some people whose insurance needs decline as they get older and accumulate more money on their own. As always, talk with an independent agent who can get multiple insurance quotes for you so that you can get the best price for your insurance policy.

What do you think? Did you buy a term life insurance ladder when you purchased your insurance policy? If so, how did you structure your ladder?