Survivorship life insurance, also known as joint survivor life insurance or second-to-die life insurance, insures two lives and pays the death benefit upon the death of the second insured person. This type of policy is typically used for estate planning purposes but is also often used for parents of children with special needs. The two most common types of survivorship life insurance are Universal Life and Whole Life insurance. Term life insurance, being only temporary coverage, doesn’t make sense for this type of coverage (as evidenced by the fact that, at the date of this writing, only one company offers such a product).
Survivorship Life Insurance for Estate Planning
If a married couple has an estate that exceeds the exemption equivalent of the Estate Tax Unified Credit allowed by the federal government, an estate tax will be due on the amount exceeding the exemption amount. Rather than leaving their heirs to liquidate all or part of the estate in order to pay this “death tax,” families who have accumulated significant estates purchase survivorship life insurance solely for the purpose of paying this tax. As the cost of the life insurance is usually significantly less than the tax liability would be, proper planning allows you to basically pay the tax with “discounted dollars.”
As the policy pays upon the death of the second insured person, the premiums for these joint policies are usually much less than if two separate policies were purchased. Also, because this type of planning is usually done by couples in their 60’s and 70’s, there’s always the possibility that one of two insured parties might be in a lower underwriting class or even be uninsurable. Because two people are being insured, as long as one of the two is insurable and not in a substandard rate class, most insurance companies would issue a policy covering both parties.
How Survivorship Life Insurance helps with Estate Preservation
In a typical situation, a high net worth family will buy survivorship life insurance via an Irrevocable Life Insurance Trust (ILIT). The trust is designated as the owner of the life insurance and the heirs are given the normal rights associated with a family trust.
When the insured individuals pass away, the life insurance company pays the death benefit to the trust. This allows the death benefit to be controlled by the trust and assures that it is not treated as part of the estate or inheritance.
The reasons stated above are perhaps the two biggest reasons why survivorship life insurance is primarily used for high net worth families. The uncertainty of the estate tax law means that high net worth families will desire to implement a legal strategy in order to avoid or minimize any estate tax consequences.
And, having immediate liquidity from the lump sum death benefit avoids having to sell off assets in order to raise cash to settle the demands of the IRS.
Why Policy Ownership is So Important
The primary question with regard to insurance for estate planning is who is better suited to own the policy. Here are some advantages and disadvantages regarding ownership situations:
Owned by an Insured
If the life insurance is owned by an insured, the advantage is that he or she has continuous control over the policy and any cash value that accumulates in the policy. However, in this scenario, the death benefit of this policy would be subject to estate tax and the three-year inclusion would apply if it’s transferred out of the estate.
Owned by a Spouse
If the insured’s spouse owns the policy, you could claim that the insured does have some indirect control over the policy and any accumulated cash value. The drawback is that the replacement cost of the insurance policy would be incorporated in the estate of the spouse, and if the spouse should die before the insured, it’s feasible that the policy might revert back to the insured and be included in his or her estate.
Owned by the Children
If the children of the insureds owned the policy, the advantage is the death benefit would be included in the children’s estate, not their parent’s. But in this scenario, once again, the insured has absolutely no control over the policy, and if the children are minors, it would call for the appointment of legal guardians before the death benefit could be paid.
Owned by a Revocable Trust
If the policy was owned by a revocable trust, where the insured could still control the policy, the death benefit is shielded from possible creditors of the insured. However, since the insured has an incident of ownership of the insurance policy through the revocable trust, the death benefit would be included in the insured’s gross estate and therefore could be accessible to creditors.
Owned by an Irrevocable Trust
If, however, the policy is owned by an irrevocable trust as mentioned above, there is absolutely no inclusion in the estate, and there is an embedded mechanism via the trust language for the continuation of the policy if the insured becomes incompetent. The downside is that the insured does not regain any control over the policy and cannot revoke the trust.
Some Disadvantages to Consider
Although using Survivorship (Second to Die) Life Insurance is typically the best solution for estate preservation, it would be inappropriate not to discuss the disadvantages:
A major disadvantage of survivorship life insurance is that there won’t be a death benefit paid until both insureds have passed away. In other words, this is not a financial solution to replace your income for your spouse, in fact, it could become a financial burden to your spouse if you are unable to pay the premium. However, a surviving spouse can sell the policy if a financial crisis should arise.
If a married couple has a survivorship policy but then later decide to split up and get divorced, the policy is still in place, and premiums will still have to be paid. If one person dies, and the survivor decides to remarry, the premiums still need to be paid. In some situations, however, the new spouse may not be happy with the idea of paying insurance premiums on a survivorship insurance policy that will not benefit their own heirs.
Certainly, most everyone is a fan of cash value life insurance. Nevertheless, with survivorship life insurance the focus is not on cash value but on the death benefit that will serve to preserve the estate. This certainly doesn’t mean that cash value will not accumulate, only the intention of the insurance policy is estate preservation rather than return on investment or cash accumulation.
If Available, Take Advantage of Riders
Depending on the insurer you apply to, there are various riders that can be purchased to broaden coverage and further preserve the estate in question:
Accelerated Death Benefit: This rider is triggered when certain events occur to the named insureds. Typically, the rider will pay a portion of the death benefit to the insured if they are diagnosed with a terminal illness that will result in death within a year.
Waiver of Premium: This rider will protect your insurance policy from lapsing by waiving premiums if an insured becomes totally disabled. The waiver of premium rider is typically available to under 60 years old.
Policy Split Option: This option, if available, allows the insured spouses to split the death benefit into separate policies if a divorce occurs or there are changes to specific tax laws that would negatively impact the policy.
Estate Protection Rider: An estate protection rider that provides additional term life insurance if an ILIT has not been set up prior to the policy being issued and both insureds die within the first four policy years. The additional term life insurance helps offset the effect of federal and/or state estate taxes on the death benefit; keeping the original policy benefit intact.
Sample Survivorship Rates
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Sample Survivorship Rates are Estimated Premiums
These sample survivorship rates are based on published premiums from A (or higher) rated companies as of 9/30/13. Premiums are based on lifetime annual payments with a guaranteed lifetime death benefit of $1,000,000. While we can estimate your health class, the final determination is made during the underwriting process. These survivorship rates are for husband and wife of the same age and are for illustrative purposes only. These rates may not be available in all states.
Parents of Special Needs Children
These policies are also often used for parents of special needs children to ensure that their needs will be cared for if both parents should die. While we are knowledgeable in life insurance matters and can help structure the right policy for this purpose, there are a lot of professionals working in the area of special needs children who can help guide you through this very specialized planning.
For a good place to start, we recommend the Special Needs Alliance (www.specialneedsalliance.com), an organization of about 100 attorneys specializing in planning for families with special needs children. These attorneys typically provide the necessary services including:
Drafting a letter of intent. This letter would provide instructions to your trustee and guardian as to how to care for your child. It would include a description of your child’s medical history, current needs and other important information needed by the caregiver in the event of the deaths of both parents.
Drafting a will to establish when and how your assets will be distributed. Without a will, your child would most probably have to wait for the end of a long probate cycle to affect the transfer of your assets.
Setting up a Special Needs Trust to manage the assets of the special needs child. By distributing your assets to a trust, rather than directly to the child, you are also protecting your child’s eligibility for government benefits (assets in excess of $2,000 distributed to the child could make your child ineligible for those benefits).
Recommending a funding mechanism for the trust (Typically life insurance).REQUEST A QUOTE
As I mentioned earlier, we can assist you to help you set up the correct insurance policy to fund the trust in the event of death. Joint Survivor or Second-to-Die life insurance is the insurance product generally used to fund a Special Needs Trust for a two-parent family. The policy will pay the beneficiary (the trust, in this case) upon the death of the second parent. The trust will have instructions as to how and when the funds from the insurance policy should be distributed. Also, life insurance policies are often acquired on each of the parents so that the financial burden on the remaining spouse would be eased in the event of one parent’s death.