Survivorship life insurance

Understanding survivorship life insurance

Some families have unique situations in which traditional life insurance policies may not meet their complex needs. For special estate planning situations, the life insurance industry has created survivorship life insurance.

Survivorship life insurance, also known as second-to-die insurance, is one policy that covers two lives. The death benefit is paid to the beneficiaries when the second insured person dies.

Survivorship policies are primarily used as an estate planning tool. They were first developed in the early 1980s when estate tax laws changed to enable married couples to postpone federal estate taxes until both spouses pass away. Once both spouses pass away, the policy’s death benefit can help pay estate taxes owed on the transfer of an estate to its heirs.

Common uses for survivorship life insurance
This is especially helpful if a couple’s estate is comprised mostly of non-liquid assets like a business, farm, real estate, artwork, automobile collection or other valuable items. If the total value of the estate is enough to trigger an estate tax bill, but there isn’t enough cash from the estate to pay it, the heirs would have to sell some of the estate’s assets to pay the taxes due.

Similarly, if a couple has a large 401(k), IRA or other qualified plan, a non-spouse beneficiary of that fund will owe income taxes upon receiving that money. The potential tax could deplete a large portion of the account. A survivorship life insurance policy can provide enough money to pay the income tax, ensuring that most or all of the qualified plan funds stay with the beneficiaries instead of going to the government.

Another use is to even out the transfer of an estate if it includes non-liquid assets such as a business or real estate. For example, a couple may have three children and a family business. Only one of the children is interested in the business, which accounts for two-thirds of the total value of the couple’s estate. To ensure the other two children receive an equivalent amount, the couple could use a survivorship life insurance policy. They could split the death benefit in a way that each child receives an equal inheritance, factoring in the value of the business and other parts of the estate.

If a couple wants to pass along their estate to multiple family members and a favorite charity, a survivorship policy can also be an effective tool. For example, the couple may own highly appreciated assets that, if sold, would require capital gains taxes. But they could donate them directly to a charity upon their death and not owe capital gains taxes. A survivorship policy could then be used to replace the value of that asset for the sake of the family beneficiaries.

Couples with a child who has special needs sometimes use survivorship policies to fund the child’s care expenses in the event they both pass away before the child.

Grandparents can purchase a survivorship policy as a way to leave a legacy split among their grandchildren after both have passed away.

The flexibility of survivorship life insurance
In addition to its many uses, survivorship life insurance is also fairly flexible in its design and cost. Survivorship policies are offered as fixed-rate universal life policies, whole life, index universal life and variable universal life.

One survivorship policy is typically less expensive than two comparable individual policies. That’s because the insurance company is taking on less risk because it owes nothing until both insureds pass away.

Because of the lower risk involved, it’s also easier to qualify for a survivorship policy. In fact, some insurance companies will allow one of the two insureds to be rated as uninsurable as long as the other insured is low-risk underwriting.

One potential pitfall of this type of policy is that, even after the first insured has passed away, premiums must be paid on the policy, enough to keep it in force. Therefore, if a couple is insured by a survivorship policy and only one of them earns income, the surviving insured may have difficulty keeping up the premium payments if the income-earning spouse dies first and there is insufficient liquid assets remaining in the estate. If this is a possibility, the income-earning spouse may also want to buy a term life insurance policy to allow the surviving spouse to continue paying the premiums and other expenses.