How and When to Use Survivorship Life Insurance
A survivorship life insurance policy insures two or more people and pays the death benefit (the proceeds) either upon the death of the first insured to die, or both people. The most common form of survivorship life insurance, and the type that will be discussed herein, is one that pays the proceeds upon the death of the last-to- die.
A second-to-die life policy, when the insured parties are close in age and health, allows for a lower premium than a single life policy, or policies. This is because the insurance carrier does not expect to pay the proceeds as quickly as it would on a first-to-die policy or single life policy, as it is actuarially unlikely that both insureds would die simultaneously. Using a simple example, a $4,000,000 (the amount of death benefit) survivorship policy (using a conservative traditional universal life contract) insuring a married couple, in good health and age 70, costs $83,300.00 a year for 30 years. Conversely, separate $2,000,000 policies of the same type, one on one spouse and the other on the other spouse, would cost $108,800.00 a year for 30 years ($61,700.00 per year for the husband and $47,100 per year for the wife). The survivorship policy at $83,300.00 costs much less than the $108,800.00 for the single life policies, hence its appeal.
That stated, a survivorship policy is not always the best solution. Consider a situation, for example, where one spouse is significantly older than the other and in poorer health. In such a circumstance, a survivorship policy is primarily based on spouses life, so much so that the cost of a single life policy insuring the spouse might be only nominally more expensive than a survivorship policy. If that is the case, a single life policy might be a better bet, as there is still a possibility of the spouse predeceasing her husband.
Second-to-die policies are popular with couples who are concerned about creating a legacy and/or ensuring that their estate has liquidity to pay estate taxes which, because of the unlimited marital exemption, are often payable upon the second-to-die of a married couple. For this reason, our clients with taxable estates have their survivorship life insurance owned by an irrevocable trust, thereby shielding the proceeds from estate taxes. While the lower cost of survivorship is attractive, it may not always be the best option, or the entire solution. Sometimes, there is a need for liquidity upon the death of the first spouse, such as when assets pass to a non-spouse beneficiary. Or, if premiums are being funded by annual exclusion gifts to the trust by the married couple, half the permissible amount is lost upon the death of the first spouse. Consequently, it may be prudent to own a small single life policy on each insured in addition to the survivorship policy. Thus, in the likely event one insured predeceases the other, the trust will have adequate cash to pay the premiums on the remaining policies, without eating into the surviving spouse’s lifetime gift tax exemption.
Some instances where our clients have employed a survivorship policy:
Ready Source of Cash for Estate Taxes and/or other Post Mortem Obligations. Assume a couple has a taxable estate that is comprised primarily of illiquid real estate, or artwork. The family may not wish to part with these assets, even if they could in a timely manner, to pay estate or other taxes. President elect Trump may target the federal estate, and possible other transfer taxes, for repeal. Nevertheless, in the event his administration does pursue this path and is successful, taxpayers will likely still need to be concerned with state estate taxes and the federal capital gains tax. A survivorship policy held in an ILIT, irrevocable life insurance trust, can provide the needed funds. The trustee can swap assets with the executor/rix, so that the estate gets the needed cash and the trust gets the assets the children want to keep (the aforementioned real estate or art).
Legacy Creation. Not every client has extensive real estate, a family business, or traditional investments to pass to heirs. Some clients simply want to be certain that their children or other heirs will inherit at least a certain amount. A client recently expressed concern that his three teenage sons may not “do as well” as he did, and wants them to have financial security. With a $6,000,000 survivorship policy, he and his wife know that sons will each get $2,000,000, no matter what. Moreover, having the proceeds in the trust provides asset protection benefits.
Hedge against Premature Deaths. There are several estate or income enhancement strategies that work best when a person lives for a longer period of time, or for a certain amount of time, such as charitable remainder trusts, grantor retained annuity trusts, qualified personal residence trusts, and life-only pensions/annuities. For example, a couple might elect a pension option that pays annually as long as one of them is living, rather than a large initial lump sum. If the husband and wife die prematurely their heirs would effectively be disinherited. In such a scenario, the heirs would be “made whole” if some of the pension money purchased a survivorship policy.
Equalize Bequests. Some of our clients are owners of a family businesses and in some instances one or more children are being groomed to run the business. Frequently, a business owner in this position also has children who are not involved in the business. Generally, our advice is to gift or bequeath the business to the child who is the successor, and not to all the children. More often than not, if the business is left to all the children when only one child is running the business, it can cause resentment and friction. This is because the successor child may be angry that he or she is doing all the work and the others are getting “paid” for nothing. Or, the non-management children may try to dictate how the business is being run (when they are not qualified to do so). A survivorship policy can solve the problem. The business can pass to the successor child and the other heirs can receive the policy’s proceeds.
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