Time to step on the 'ladder'?

By Allen Wastler
Allen Wastler is a former financial journalist with over 30-years of experience, including time at CNBC, CNN, and Knight-Ridder Newspapers.
Posted on May 3, 2018

You’ve graduated, got a specific skill set, invested in yourself, and are starting your career. What’s a good strategy for preparing for what’s ahead in life? Many people at this stage turn to “laddering” —  the idea of using a variety of life insurance policies to address particular risks for specific periods of time.

Laddering is not a concept confined to insurance. It is a general financial concept. It’s the idea of buying several smaller monetary vehicles of varying durations instead of one large one. These smaller “rungs” may provide steadier returns and more flexibility than a single, large investment.

Laddering in finance

Bond investors using the ladder technique, for example, may choose to invest in several different bonds maturing at different times rather than one large bond maturing far off in the future. That way, they have a stream of capital as bonds in the portfolio mature. And should something go wrong with the long-term bond market, not all of their investment is committed to it.

Some savers use the laddering technique with certificates of deposit (CDs). Instead of buying a single large CD for $3,000 that matures in five years, a laddering-saver would perhaps buy three $1,000 CDs:

  • One that matures in one year.
  • A second that matures in three years.
  • And a third that has a five-year maturity period.

As the CDs mature with interest, the money could be reinvested in another five-year CD, creating an ongoing cycle of investment returns. Or, if the need arises, the cycle allows for cash from the investment to be available every two years.

The same idea can be applied to life insurance to build a comprehensive protection strategy by buying different kinds of policies at varying lengths or at different times to serve specific functions and address particular risks. Taken individually, each policy may fall short of a comprehensive plan. But taken together, they may offer the kind of overall coverage ideal for certain individuals. (Calculator: How much life insurance do I need?)

Take, for example, someone who just graduated from a professional school and is starting a family. Money for such an individual is typically tight. But there are still certain obligations to plan for: paying off student debt, getting kids through school, paying off a mortgage, and building for retirement for you and your spouse.

One large whole life insurance policy could possibly cover all the needs. Provided you keep up with the premiums, a whole life insurance policy covers you for your whole life and has the added benefit of building up cash value and possibly paying dividends. (Learn more about whole life insurance here.)

But large whole life policies can be expensive. And they could also be providing long-term coverage for what’s only a short-term need.

A life insurance combination

A better strategy for some people might be buying a small whole life policy and supplementing its coverage with an assortment of term life insurance policies. Term insurance provides coverage for a specific period of time. But it doesn’t include the benefits of whole life insurance. So it tends to be cheaper. (Learn more about term insurance here)

But the low cost of term insurance means that it might be able to offer less expensive options for coverage in tandem with other policies.

“The advantage here is that we can procure a substantial amount of death benefit for a relatively low out-of-pocket cost,” commented Brian Roberts, CFS®, cofounder of R&F Financial Group in Chesterfield, Missouri, in an email exchange. “The downside to term insurance is that it only lasts for a certain duration of time. The challenge is that our clients’ needs oftentimes extend beyond the duration of the term. This can pose a problem. This is where permanent life insurance can be a viable solution. The advantage of permanent insurance is that it lasts forever or until death. This way the client is assured their needs are met and their families are taken care of. The challenge is that the capital investment for permanent insurance is higher than term insurance. This is where we see clients finding the advantage of laddering their coverages.”

So how does such a strategy work in practice?

Let’s take the hypothetical case of a starting-out professional. He or she could buy a small whole life policy, but also supplement it with:

  • A 10-year term policy to cover any student debt obligations.
  • A 20-year term policy to cover possible college costs for children.
  • A 30-year term policy to make sure a spouse can manage mortgage or retirement needs.

This laddering arrangement provides a way of addressing different financial issues at various times of life. And it provides a tailored way of only paying for as much coverage as needed.

Beyond covering the specified risks, this strategy can provide some flexibility as well. Term insurance typically allows for extensions, albeit at higher rates, if desired. So if there is some reason for continuing one of the intermediate term policies — say providing support for a small business that was started with a partner — the option is there.

Depending on the terms of the whole life policy purchased, there are possibly other advantages as well. Whole life insurance typically costs less when the purchaser is young and healthy. But it can be purchased with provisions, called riders, that allow for additional coverage without having to go through the underwriting process again.

Also, term insurance can be converted to permanent insurance. In exchange for the higher price of the permanent insurance is greater flexibility and options, including the possibility of accessing its cash value for income at a later date. Certain permanent insurance types, like whole life, offer the chance of yearly dividends, although dividends are not guaranteed. Also, policyowners can borrow funds from a whole life policy’s cash value, which can be used for supplemental retirement income. Of course, tapping cash value has ramifications for the death benefit, may mean tax bills should the insured pass on, and increases the chances of the policy lapsing altogether.

“There will come a time to consider converting some of your term life insurance to permanent coverage,” said J. Todd Gentry, a financial professional with MassMutual St. Louis. “Permanent life insurance provides a death benefit, yes, but it also serves the strategic goal of creating income-generating options when you retire. The sooner you begin tackling the goal of owning some permanent life insurance the more options you will have in the future. This is all about creating options and flexibility.”

So, with the laddering strategy suggested here, the money that was used to pay premiums for term policies could be redirected to bolster the coverage and value within the whole life policy. That could be useful as the purchaser ages. And if the whole life policy has riders allowing for the waiver of premiums or the acceleration of death benefits in the event of a disability, even better. (Learn more: Understanding insurance riders)

Different needs

Of course, such life insurance laddering tactics should differ from person to person, as financial circumstances and needs are different.

“Every client’s situation is unique,” said Roberts. “We try to work with the client to evaluate their needs today and down the road. These needs span from debt elimination, education planning, surviving-spouse income, mortgage elimination, and final expenses.”

Some differences in needs or aims of individuals could mean:

  • Someone may want to build their particular insurance ladder over time as circumstances warrant, instead of all at once.
  • At the beginning of their career, someone who has a specific skill set or relies greatly on their hands, like a dentist, musician, or a welder, may want to make a disability income insurance policy a focus instead of focusing just on life insurance rungs on the ladder.
  • Or, if unsure about their career track or what kind of financial obligations they may have down the road, someone may opt not to follow a laddering strategy at all.

Also, as noted earlier, a lot depends on the combination of policies involved and what type of options are selected in the coverage. Many people opt to discuss their own situation with a financial professional as the options can get complex.

But it helps to know beforehand…you can always use a ladder.

Learn more from MassMutual…

A financial checklist for your first job

Millennials and retirement: The ‘to-do’ list

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The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own, and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.