Published September 10, 2012
A couple's best-laid plans to pass down assets such as real estate, businesses, investments or art work could easily go awry if the children have to sell off that stuff at fire-sale prices because Mom and Dad failed to set aside enough cash to pay the estate taxes.
To avoid this sad scenario, estate planners turn to an obscure life insurance instrument called survivorship insurance, or second-to-die insurance.
Unlike a traditional life policy that pays benefits upon the death of an insured individual, a survivorship policy covers the lives of two people and pays benefits only when the second person dies.
Why would you want this? Well, estate planners typically use these policies to cover the estate taxes of wealthy couples. Since the unlimited marital deduction allows assets to pass tax-free to a widow or widower, a survivorship policy delays the life insurance benefit payout until the death of the second spouse, when the infusion of cash is needed to take care of the estate taxes.
A second-to-die policy also may be useful for business partners, dual-income parents and couples who want to provide lifelong care for a special-needs child. The purpose is always essentially the same: to provide the cash to pay anticipated estate taxes on an illiquid estate so the assets don't have to be sold off piecemeal or at an inopportune time.
Survivorship policies have been on the uptick recently with the Bush-era estate tax exemption set to expire Dec. 31, 2012. Unless Congress extends it, the current $5 million exemption would revert to $1 million, exposing even more estates to federal estate taxes.
"Right now, the recommendation is that if your estate is worth $5 million-plus, you better get the survivorship insurance," says life insurance analyst Tony Steuer, author of "Questions and Answers on Life Insurance." "The estate tax is not going to go away; it's just a question of where it's going to land."
Single purpose, many advantages
Besides the help with estate taxes, survivorship policies typically offer these other advantages:
Favorable underwriting: Because the policy is based on two lives, underwriters use a different and more lenient mortality table than those used for individual policies. "Because they're underwriting both of you, even if one person is uninsurable, if the other person is in good health, you can usually still get the policy," Steuer says.
Lower premiums: Since survivorship policies usually don't build cash value and don't pay out until the second spouse dies, the rates are typically lower than for two comparable, more traditional life insurance policies.
Return on investment: A survivorship version of permanent, universal life, or UL, with a guaranteed death benefit may pay out the full benefit long before the insured persons have paid off the policy.
While a survivorship policy itself is more complex than a standard life insurance policy, its effectiveness depends on how well it is integrated into a comprehensive estate plan, according to Suzanne Krasna, a Certified Financial Planner in Walnut Creek, Calif.
"First of all, you want to have an irrevocable life insurance trust set up where the trust is the owner and beneficiary of the life insurance," Krasna says, explaining one strategy for maximizing the tax advantages. "As the trustees, the husband and wife would gift the money to the trust to pay the premiums; currently, between the two of them, they would be able to put in $26,000 a year at the current (tax-exempt) limit."
Steuer says some couples cash out their individual whole life policies and place the accrued cash in a trust to fund a survivorship UL policy designed to cover their likely estate taxes.
"Even if they have to pay some taxes on the cash value from their whole life policy, they'll still have enough cash there to pay the premium for the new policy and still come out ahead," Steuer says. "You want the lowest-cost guaranteed UL product you can get."
Survivorship and young families
Young parents also might want to consider a survivorship policy, though for more basic reasons than estate planning, says Jonathan Bauer, an estate lawyer and partner at Meuleman Mollerup, a law firm in Boise, Idaho. He and his wife took out a $1 million survivorship term life policy for several years to protect their children.
"If you're a young couple and one of you has a medical condition that makes life insurance really expensive, it's a cheaper alternative than even individual term policies," he says. "It's a comfortable alternative to address every parent's natural fear of, 'Gosh, what happens if we both go down on this vacation to Hawaii?' It isn't the best option if money weren't an issue, but it is a stopgap that is reasonably affordable."
Intrigued by second-to-die life insurance? Steuer says don't try it alone.
"If you need it, it makes sense. If you don't need it, it doesn't. But probably the biggest mistake people make is they try to do this without a properly qualified estate planning attorney," he says. "This is one of those areas where you really cannot get by without one."