Most people think of life insurance as only insuring a single life. However, there are policies that insure two lives which are frequently used as part of an estate or business plan. These are typically permanent policies and depending on the insurer might include whole,universal, index or variable life.
Survivorship or Second to Die Policies
A survivorship or second to die life insurance policy is designed to insure two lives in one policy with one premium payment. The policy only pays a death benefit when the second of the two insured passes away. There is no death benefit paid upon the first death. If there is a need for liquidity at the first death then having one or both of the insured purchase an individual term or permanent policy could make sense as well. For example, if there is a large age gap between the two insureds, such as in a second marriage.
Survivorship policies are usually purchased by married couples or individuals that have a valid reason for seeking the coverage. Otherwise, insurers may question the application for the coverage. One of the many reasons to consider a survivorship policy is a lower premium. Since the cost per thousand dollars of death benefit is based upon the joint life expectancy of both parties the premium can be significantly less than the cost of purchasing two individual policies. Also, in situations where one of the insured is younger and/or in good health and the other is older and/or has health issues insurers will often issue a survivorship policy at standard class or with a rating (an additional charge). Where, for example, if the unhealthy person applied for individual coverage they would be highly rated or even uninsurable.
Who Should Own the Policy?
Like individual life insurance, survivorship policies can have a level or increasing death benefit. The death benefit that passes to the named beneficiaries is income tax-free. If the policy is not owned by either insured and has not been transferred from their ownership within the past three years, then the death benefit will not be included in their taxable estate.
To avoid inclusion in the insured’s taxable estate, it is common for survivorship policies to be owned in an irrevocable life insurance trust (ILIT). (See also:7 Reasons To Own Life Insurance in an Irrevocable Trust.) The premium is gifted by the insured to the trust each year along with a Crummey letter. However, the policy could also be owned by other family members. The risk of having the policy owned, for example by your children, is that in the event of a divorce or lawsuit the policy cash value and/or death benefit could be attached.
Why Buy a Survivorship Policy?
Survivorship policies are frequently purchased to:
- Provide liquidity to the executor of an estate, so assets do not have been sold off to pay federal and/or state estate taxes that are due within nine months of the insured’s death. (See also: How Life Insurance Can Help Reduce Estate Taxes.)
- Equalize inheritance between children. For example, if one child inherits an illiquid family business or property the insurance proceeds can be distributed to the other children.
- Replace wealth spent during the insured's lifetime. For example, deciding to self-fund long-term care expenses
- Fund charitable contributions
Depending on the insurer, survivorship policies offer a number of riders (some free and some at an additional cost) that can be attached to the policy when issued including:
- An accelerated death benefit or long-term care rider. The rider is triggered if certain events occur, such as being diagnosed with a terminal illness, and allows access to the death benefit while the insured is still alive. Some tax issues around this benefit are still unclear if the policy is owned in an ILIT since a lie is placed on the death benefit, and the rider is triggered by the insured.
- Disability waiver of premium, if the insured is under a certain age, usually 55 or 60 when the policy is issued.
- A policy split option which allows the owner to split the policy death benefit into two separate individual insurance policies if certain triggering events occur, such as a divorce or changes to specified tax laws. The insured do not have to go through underwriting and depending on how the new policies are issued there could be tax implications.
- An estate protection rider that provides additional term life insurance if an ILIT has not been setup 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. The amount of additional term coverage provided varies by company, for example, $250,000, and there is usually an additional charge for this rider based on the insured ratings.
The Bottom Line
Survivorship policies can be an effective estate planning tool, but may not eliminate the need for individual coverage. When designing a life insurance plan, it’s important to look at the big picture and purchase coverage to meet all your needs which may entail having several different policies to meet your overall goals.