It’s a final gesture of love, a way of helping to ensure that your heirs will be cared for and have the means to carry on after you are gone. In terms of looking out for those you love ― physically, emotionally, and financially ― it’s one of the ultimate acts of mutuality.
Called survivorship life insurance, it’s life insurance that covers two policyowners and pays off at the second death.
That makes it a useful way to help a surviving partner carry on. But it also has long been favored by affluent couples looking to lighten the future tax burden for their heirs. And, as an estate planning tool, it can still deliver.
But such policies, also called second-to-die life insurance, may help meet other financial needs, too.
Survivorship policies, for example, may be ideal for married couples with a special needs child, or for business partners who wish to plan for an orderly transition of ownership.
A look at how survivorship life insurance works, when it might make sense, and a few potential alternatives can help shed light on whether such coverage is a potential fit for you.
What is a survivorship policy?
Survivorship policies were introduced in the early 1980s following a change in the tax law allowing a couple to defer all estate taxes until the last one dies. It is generally sold as a whole life, universal life, or variable universal life insurance policy. (Learn more: Types of life insurance )
Because it does not pay out until both policyowners have died, survivorship life insurance typically provides a much bigger death benefit than two individual policies would be able to for the same premium, said Steven Weisbart, senior vice president and chief economist for the Insurance Information Institute .
As with most life insurance policies, the proceeds from a survivorship policy are generally income tax—free to the beneficiary.
Such policies are not ideal for couples in which the surviving spouse needs to collect an insurance benefit to help cover expenses or maintain their standard of living after their partner passes away, said Weisbart.
But they may be worth exploring for those who wish to insulate future generations from specific forms of financial risk, he said.
Survivorship policies are most commonly used by wealthy couples as a mechanism to provide their estate with liquid assets and minimize the impact of estate taxes to their heirs.
A little background may be useful. Under current law, married couples don’t need to worry about estate taxes after the first spouse passes away, because the marital deduction allows the first to die to pass unlimited assets (all property included in their gross estate) along to the surviving spouse tax-free.
Estate taxes, however, are due after the death of the second spouse on assets that exceed the federal estate and gift tax exemption amount, which is $11.18 million per individual for 2018. (Married couples can shield $22.4 million from federal estate and gift taxes.)
Currently, the top federal estate tax rate is 38 percent, which can take a big bite out of the financial legacy wealthy families leave behind. On a $21.18 million estate, for example, that 38 percent tax would be applied to $10 million – costing the heirs nearly $4 million.
Take note that some states (12, plus the District of Columbia) levy their own estate tax, and six have an inheritance tax, which often imposes tax on much smaller estates.1
So where do second-to-die policies come in? They can potentially provide the liquidity — or immediately available cash flow — to pay the administrative costs and estate taxes due on your estate when both you and your spouse are gone. That assumes, of course, that the death benefit is sufficient to pay what is owed, and that the policy is still in force when the second spouse dies. (Related: How much life insurance do I need? )
Absent a life insurance death benefit, their next of kin might otherwise be forced to sell their inheritance (art work, stock investments, real estate) at a fire-sale price to raise money quickly.
Life insurance proceeds pass directly to the policyowners’ beneficiaries, avoiding the expenses and delay of probate.
“You could also buy separate life insurance policies and when the second person dies the death benefit would pay the estate tax, but that means you paid a lot of premiums on the policy of the person who died first,” said Weisbart. “A second-to-die policy avoids that waste.”
Retirees who want to leave a financial legacy
Survivorship policies are not exclusive to high-net-worth families, however. Retirees of lesser means who wish to leave a financial legacy for their heirs (or a charity) may also find such policies give them the financial freedom to spend their savings on travel or future medical expenses without fear of depleting their estate, said Marguerita Cheng, a financial professional and chief executive of Blue Ocean Global Wealth in Rockville, Maryland. Those entering retirement, for example, may be positioned use a portion of their savings to purchase a survivorship whole life policy that would guarantee their children receive a tax-free death benefit after they have both died.
“Survivorship policies or second-to-die policies can be a helpful solution to address estate planning issues,” said Cheng.
In the case of a whole life survivorship policy, the guaranteed cash value their policy would accumulate could also potentially be accessed later in retirement if their other assets have been depleted. (Note: Access to cash values through borrowing or partial surrenders reduces the policy’s cash value and death benefit, increases the chance the policy will lapse and may result in a tax liability if the policy terminates before the death of the insured.) (Related: Treat Cash Value With Care )
Couples with a Medical Condition
Survivorship policies may also make sense for couples of any net worth if one spouse has a medical condition that would make it cost prohibitive — or even impossible — to obtain coverage on their own, said Cheng.
Because they provide coverage based on two life expectancies, second-to-die policies typically cost far less than a single-life policy for the same amount of coverage, she said, noting they generally also offer more favorable – or lenient – underwriting, making it potentially easier to qualify for coverage.
“As clients age, underwriting or the cost of insurance may be an issue,” said Cheng. “It’s easier and more cost efficient to have the one policy.” Affordable premiums are important, she said, because policyholders need to be able to make their payments on time to keep the policy in force.
Cheng said she also encourages clients with a medical condition to take advantage of group life insurance coverage that may be available through their job, as many employers do not require stringent underwriting.
Special Needs Planning
For most parents of a disabled child, leaving that child in good hands after they are gone is their top financial priority. The death benefit from a second-to-die policy is one way to potentially help ensure that costs related to that child’s ongoing care will continue to be paid.
Ken Shulman, an estate planning lawyer with Day Pitney LLP law firm in Boston, Massachusetts, who works primarily with special-needs families, said survivorship policies are frequently used to fund a Special Needs Trust, designed for beneficiaries with disabilities.
“Survivorship policies work very well for families with special needs considerations, but they are not the only funding mechanism for a Special Needs Trust,” he said, adding a word of caution. “Trusts should never be used in isolation. They should be integrated into a comprehensive tax-efficient estate plan that considers all your family financial planning needs.”
Shulman also said that Special Needs Trusts should be structured in a way that helps preserve the child’s eligibility for Medicaid and other needs-based government programs. “Public benefits law is constantly changing so, in this situation, I would stress that families should make sure they consult someone who understands this area of the law,” he said.
Business transition planning
Often, the policyowners on a survivorship life insurance contract are a married couple, but they don’t have to be. Survivorship policies can cover any two people, including a parent and child or two business partners.
Family-run businesses and companies owned equally by two unrelated partners sometimes use a second-to-die policy to provide the funds needed for the smooth transfer of ownership of the business after both partners pass away, said Weisbart. The death benefit, which can be divided equally among the business partners’ heirs, can help ensure that those interested in taking over the business would be positioned to do so, while the heirs who are not interested would receive money instead.
As an alternative, business partners may be able to purchase a life insurance policy on each other as part of a buy-sell agreement legal contract, providing a death benefit if a partner passed away, to help ensure the business would survive. The surviving partners could also potentially use the life insurance proceeds to buy their late partner’s share from the decedent's heirs.
(Related: Business succession planning )
Here again, however, business transition planning is highly complex — with much at stake. Weisbart recommends partners work closely with a lawyer or financial professional well-versed in the area.
Survivorship life insurance wears many hats. Apart from its role as an estate planning tool, it could also help provide financial support for a disabled child or give spouses with a medical condition better coverage options.
“We know that it’s not a matter of if we will die, but when,” said Cheng. “We all leave this world sometime, and second-to-die policies can help address some of the financial issues many people face.
Before you jump in, however, consider all alternatives and talk to a financial advisor or attorney for guidance on whether such coverage might make sense for you.
Learn more from MassMutual…
1 Tax Foundation, “Does Your State Have an Estate or Inheritance Tax?” April 5, 2018.