[Editor's Note: This is a guest post from Jon Sycamore CFP®, founder of Physician Wealth Planning. The subject of laying/laddering term life insurance policies has been discussed on this site in the past, but it was over 3 years ago, so I thought it was worthwhile to hit it again. Jon and I have no financial relationship.]



Financial professionals have a bad reputation among consumers. I’m a financial professional, and I agree that it’s not without cause. There are a lot of people swimming in the financial services pool and a lot of them are, well…incontinent.  It’s getting better though. You may or may not be familiar with the Department of Labor’s fiduciary rule, but basically, it requires anyone giving advice on retirement accounts to put the client’s needs ahead of their own. I’ll spare you the details, but the point is that the bar is being raised on financial professionals. While there’s still a ways to go, I think the biggest culprit contributing to financial professionals taking advantage of consumers is the sale of commission based products. Many investment advisors have already gone away from selling products to charging a fee for services, but it’s still the standard in the insurance industry.

There’s a saying, “Insurance is sold, not bought”. You, the customer need to watch out for overzealous salesmen who will tug at your heartstrings to convince you to buy as much insurance as you can afford. I mean, you love your children, don’t you?

Jon Sycamore

Jon Sycamore, CFP

I’m not trying to trash on insurance professionals here.  In fact, I’ve found that they are raising the bar on themselves despite the DOL rule having no jurisdiction on most insurance sales.  I recently attended a webinar hosted by Mark Maurer of LLIS, where he talked about layering term insurance to save client's money. This strategy involves multiple smaller policies of varying lengths that reduce the amount of insurance over time as the client’s need diminishes. Before, you’d probably just be sold a single large policy so the salesman could collect as much commission as possible.  Putting your client’s needs first!  What a concept!

Determining How Much Term Insurance You Need

Before we go any further, it’s important to understand how much insurance you need over time.  There are two approaches you can use to determine how much insurance you need, an important part of buying term life insurance from independent agents.

# 1 Human Life Value

The human life value approach to determining term insurance needs estimates all future earnings, minus taxes and self-maintenance.  This is the more straightforward approach as it simply looks at your earning potential and attempts to replace it.

#  2 Capital Needs Analysis

A capital needs analysis is a bit more cumbersome but is more precise.  It looks at your needs individually and attempts to fund them.  It doesn’t have to get too granular but usually looks at paying off large debts like a mortgage or student loans, funding education, basic living expenses, etc.

Regardless of the approach you take, you’ll end up with a series of cash flows for a given amount of time.  Rather than simply adding up all future cash flows to get an enormous number, you choose an investment rate of return you think is realistic, then calculate the present value for each future cash flow and sum those numbers to get the net present value (NPV).

The NPV minus any liquid savings you have is how much insurance you need today.  But what about in the future after you’ve had a chance to accumulate more in savings and many of those initial cash flows have passed?  The amount of insurance you’ll need is reduced.  This is where layering term insurance comes in.

Hypothetical Example

Let's say you’re a 35-year-old female physician in good health and you don’t smoke.  Your gross income is $275,000, you pay a combined tax rate of 28%, you max out your 401(k) and make nondeductible contributions of $11,000 into your IRA and a spousal IRA (and convert them to backdoor Roth IRAs).  Finally, you determine that if you were to die, your family could live on $40,000 less.  This leaves you with $150,713.  Assuming your income only keeps up with inflation at a rate of 3% and an investment rate of return of 6%, we can project how much coverage you will need in future years.  Is your head spinning yet?  Click here for a breakdown of the numbers.  As you can see in the chart below, the NPV represented by the blue line starts at $3 million and steadily descends as annual expenses are completed and savings accumulate.

Laddering Term Life Insurance

Single Term Insurance Policy Versus Layering Term Insurance Policies

As the chart above suggests, this hypothetical client would benefit from layering term insurance as her need for coverage diminishes.  If she purchased a single $3 million, 30-year term policy, that would cost her $2,310 per year, or $69,300 cumulatively.  However, If she layers three separate smaller policies as illustrated above, she would pay $1,574 per year for the first fifteen years, then $1,234 for the next five years, and finally $810 for the next ten years for a cumulative cost of $37,880.  In total, this strategy provides complete coverage and costs $31,420 less.

Does Layering Term Insurance Apply to You?

You may be saying to yourself, “well that’s great, but that’s a lot of calculating for me to do on my own”.  You’d be right.  It is.  That’s why I’ve included this spreadsheet for you to enter in your own personalized assumptions.  For simplicity’s sake, it uses the human life value approach discussed earlier.  A capital needs analysis, however, often make an even stronger case because educational expenses tend to keeps the NPV high until after that expense is completed, then it descends at a more rapid pace.  Enter your personalized information in the blue highlighted cells and the formulas do the rest.


[Editor's Note: Three comments I'd like to make to round out the topic.

First, I am a strong proponent of the capital needs analysis method of determining how much insurance to buy because it is based on your spending rather than your income. You don't need to replace what you earn, only what you spend. For a good saver, there's a huge difference between those two. So I find that using a human life value approach is much more frequently used by an insurance agent as a method to sell you more insurance.

Second, don't forget the effects of inflation which are hardly insignificant over a 20-40 year career. A 30 year level premium policy is already layered/laddered on an after-inflation basis. In real dollars, both the premiums and benefits are higher in the first few years and lower in later years. Be sure to take this effect into account when determining your term insurance plan.

Third, I am a big fan of this strategy and have two separate term life insurance policies, a $750K policy that ends around age 52 or so and a $1 Million policy that ends around age 57. However, I'm likely to cancel them both in the next few years thanks to reaching financial independence earlier than expected and probably would have been better off buying annually renewable term insurance instead of level premium policies.]

What do you think? Did you layer your term insurance? Why or why not? How much do you expect to save by doing so? Comment below!