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Layering life insurance policies - what you need to know


 A typical life insurance policy has coverage that is level. For example, term life insurance has coverage that is level for 10,20, or 30 years. Permanent life insurance has coverage that is generally level for life.

By choosing a life insurance policy that is strictly a single level of coverage, as is typical, you’re assuming that your coverage remains level for the duration of the policy. This assumption is often incorrect. For example, many people may have coverage requirements that are decreasing as they get older. If that’s the case, then you could choose a policy with level coverage and then manually decrease the amount of life insurance as you get older. The problem with this approach is that you’re overpaying for a portion of your life insurance during the early years.

How layering of life insurance policies works:

 Here’s a simplified example. Lets say that you need $500,000 of life insurance coverage for 10 years, then $250,000 of life insurance coverage for the next 10 years (total of 20 years). Now you could purchase a $500,000 20 year term policy, then reduce the coverage to $250,000 after year 10. Or alternatively, you could purchase $250,000 of 20 year term, and top it up with a $250,000 of 10 year term. Both coverages combined give you $500,000 of total coverage for the first 10 years. Then, you drop the 10 year term and are simply left with $250,000 of the 20 year term for the remaining 10 years. This will be the cheaper option.

Lets look at some illustrative numbers:

Year  Coverage  Term 20  Term 10+Term 20 Layered
1  500,000  77/month  (25+46)=71/month
10  500,000  77/month  (25+46)=71/month
11  250,000  46  46

 Examples of Actual Layering of life insurance policies

In the above example, we layered a term 10 with a term 20. If we assume that we need a lot of coverage now for our family, but less coverage in 10 years as the kids are older and perhaps more financially self sufficient (or maybe the mortgage is paid off). This would be a common case except that since the difference in premiums is so small, most Canadians simply purchase a straight term 20 in this case – yes it’s more expensive but it’s only minimally so. And that way, they have the option in 10 years to drop the coverage to $250,000 as planned, or maintain the coverage at $500,000 if they become uninsurable or circumstances change.

A more common example that is often applied in real life however, is layering of term and permanent life insurance. In this case we assume that we need a large amount of term life insurance while we’re raising our family, but after that we would still like some coverage but for a much smaller amount. The correct way to do this is with a layer of term and a layer of permanent. For example, you might consider $450,000 of 20 year term, with another layer of $50,000 of permanent life insurance. That would give you $500,000 of total coverage for the next 20 years. Then the term 20 policy would be cancelled leaving you with the $50,000 of permanent life time coverage. BUT! Importantly, the premiums you’re paying for that $50,000 of permanent coverage in 20 years won’t be based on your age in 20 years. They’ll be based on your age now (since you purchased the coverage now, you locked in the rates). So if a 40 year old used this technique, in 20 years at age 60, their life insurance premiums for the $50,000 would still be based on the premiums of a 40 year old – since you bought it at age 40. You can image that purchasing a new life insurance policy for $50,000 at age 60 will be substantially more expensive than this.