Estate planning is a complex process that involves strategies to transfer your assets to your heirs and loved ones as efficiently as possible after you pass away. This includes minimizing taxes, avoiding probate delays, and ensuring your wishes are properly executed.
For high-net-worth individuals, taxes can become a major factor that eats into the inheritance they intend to leave behind. This is where incorporating survivorship life insurance as part of an integrated estate plan can help protect wealth and provide liquidity when needed most.
In this comprehensive guide, we’ll explore how survivorship policies work, how are survivorship life insurance policies helpful in estate planning, who should consider them, types of policies, alternatives, and key factors in choosing an appropriate survivorship life insurance policy.
What is Survivorship Life Insurance?
Survivorship life insurance, also referred to as second-to-die insurance, is a permanent form of life insurance that covers two individuals instead of one. It pays out a death benefit to designated beneficiaries only after both of the insured policyholders have died.
These policies provide coverage for spouses or partners jointly on a single policy. Because the payout is delayed until the second death, the insurer faces lower risk compared to individual life insurance policies. This allows the survivorship policy to provide larger coverage amounts at lower premium costs.
Survivorship insurance can be purchased in a variety of policy types including whole life, universal life, and variable life. The death benefit amount, premium costs, cash value accumulation, and other factors will differ among the types.
How Do Survivorship Policies Help With Estate Planning?
There are several advantages to using survivorship life insurance as part of your overall estate plan:
1. Provides Funds to Pay Estate Taxes and costs
The estate tax applied to transfers of massive wealth is one of the biggest financial burdens facing affluent families. In 2023, estates over $12.92 million face a top estate tax rate of 40%. Even with the high exemption amount, the estate tax can still take a major toll.
Life insurance proceeds are paid directly to the beneficiaries income tax-free. This provides ready liquidity to cover estate taxes and other costs so that beneficiaries are not forced to sell off assets just to raise money to pay the taxes.
Survivorship policies offer larger death benefit amounts than individual policies, making it more feasible to cover hefty estate tax bills. This helps preserve the overall value of the estate for heirs.
2. Equalizes Inheritances
High net worth estates often consist of diverse assets – some liquid like stocks and others illiquid like family businesses, real estate properties, artwork, etc.
These tangible assets are not divided equally among all heirs. One child may inherit a million-dollar beach house while another may get more liquid bank accounts. Survivorship life insurance provides a tax-free cash inheritance that can help balance unequal distributions of physical property.
3. Avoids Probate
Life insurance death benefits bypass the probate process because the policy owners designate specific beneficiaries. This provides heirs faster access to funds at a time when liquidity is most crucial to handle estate settlement costs.
In contrast, assets passing through probate get tied up for months or even years before beneficiaries can access inheritances. The estate must also pay executor and court fees out of probate assets.
4. Provides Peace of Mind
Knowing measures are in place to minimize estate taxes gives couples assurance about being able to fully transfer wealth to the next generation. Survivorship insurance death benefits prevent having to unnecessarily liquidate assets, allowing more of the tangible estate to remain intact.
Who Should Consider Survivorship Life Insurance?
While survivorship policies can benefit many people, certain situations make them particularly useful:
1. Wealthy Couples Concerned About Estate Taxes
Married couples with assets exceeding the estate tax exemption face exposure to potentially enormous estate taxes. The 40% rate can take a major toll on estates over the exemption amount if no planning has been done. Survivorship insurance helps hedge this tax risk.
2. Couples With Illiquid Estates
If the estate consists largely of assets like real estate, art, collectibles, or closely-held family businesses, selling to pay estate taxes can be problematic. Survivorship policies provide liquidity that allows heirs to retain illiquid assets and continue owning a specialized property like farms or ranches generation after generation.
3. Business Partners
Partners who co-own a business together can use survivorship insurance to ensure continuity if one partner dies. Proceeds give remaining partners or heirs the ability to buy out the deceased partner’s ownership share. This facilitates a smooth business transition.
4. Parents of Special Needs Children
Special needs children require lifelong specialized care. Parents can use a survivorship policy payable to a special needs trust to provide ongoing resources to support the child even when their parents are gone.
5. Couples Where One Spouse is Uninsurable
If one spouse has serious health issues that make purchasing individual life insurance unrealistic, the joint survivorship policy can provide an affordable way to gain coverage based on the healthier spouse’s rates.
In addition to these situations, retirees concerned about retaining assets for heirs and charitably inclined donors may also benefit from incorporating survivorship insurance into financial plans.
Survivorship Life Insurance Policy Types
If you determine a survivorship policy aligns with your estate planning objectives, the next decision is choosing what type of life insurance to implement it with.
Here are the main policy options to consider:
1. Whole Life Insurance
Whole life is a permanent form of insurance with guaranteed death benefits, level premiums, and cash value accumulation over the life of the policy. Premiums are fixed and higher than term insurance since coverage lasts a lifetime.
Survivorship whole life lets spouses or partners obtain higher joint coverage for less compared to individual whole-life policies. The guaranteed cash value offers liquidity if accessing funds while living.
2. Universal Life Insurance
Universal life provides permanent coverage like whole life but with more flexibility. Policyholders can adjust death benefit amounts and pay fluctuating premiums based on needs over time.
Cash value grows at an interest rate set by the insurance company. This gives more variability but allows larger cash accumulation than a whole life. Survivorship UL combines lower joint premiums with adjustable coverage.
3. Variable Life Insurance
Variable life insurance allows policyholders to invest the cash value portion in a variety of investment funds, similar to a brokerage account within the policy. Returns are not fixed but tied to the performance of the investments selected.
Survivorship variable life allows spouses to obtain lower joint coverage with the potential for cash value growth well beyond whole or universal life. But it also comes with higher risk.
Variable policies require closely monitoring investments and the fees charged on the policy. Returns are not guaranteed. Poor investment choices can result in decreased cash value and lapse of coverage.
4. Term Life Insurance
Term life provides temporary coverage for a set period like 10 or 20 years. It does not offer cash value buildup or permanent coverage. Premiums are the lowest among life insurance policy types.
Survivorship term can provide low-cost protection for a limited period defined in the policy, such as covering estate taxes until assets can be transferred within the term period. However permanent coverage is often preferred for estate planning.
5. Hybrid Policies
Some insurers offer hybrid policies that blend attributes of permanent and term insurance. One example is Universal Life with a long-level premium term rider for added coverage. Such hybrid approaches can be implemented as survivorship policies.
Survivorship policyholders should evaluate different types of life insurance and their features to find the right match for estate planning goals and premium affordability. Consulting a financial professional is key to navigating the choices.
Potential Alternatives to Survivorship Insurance
While survivorship life insurance offers some unique advantages, there are other options couples should consider as part of their overall financial and estate planning:
1. Individual Life Insurance Policies
Traditional individual life insurance policies covering each spouse separately can provide funds to pay estate costs at the first death. This may be a better solution if funds are needed on the passing of either spouse.
First-to-die joint policies can cover both spouses but pay the benefit at the first death. This ensures the surviving spouse will have assets to continue living comfortably. Survivorship insurance, in contrast, skips the first death.
2. Term Life Insurance
For younger couples, buying lower-cost term life insurance may make more sense. As the estate grows over their working years, they can later supplement with permanent survivorship insurance when estate tax exposure becomes significant.
3. Self-Insuring
Very wealthy couples able to self-insure may opt to simply set aside assets to cover expected estate taxes. Conservative investments can fund future tax liability without paying insurance premiums. This strategy requires substantial excess liquid assets.
4. Living Trust
Assets placed in an irrevocable living trust can reduce the size of the taxable estate. Income from assets in the trust can help fund premiums for individual life insurance policies to cover estate costs.
Key Factors in Choosing Survivorship Life Insurance
If after assessing alternatives you decide that survivorship life insurance aligns with your goals, here are some key considerations as you evaluate policy options:
- Goals: Define what assets you want to protect or transfer then quantify the liquidity needed. This helps determine the appropriate death benefit and premium costs you can afford.
- Finances: Review assets, incomes, debts, and expected future circumstances. Consider your overall financial picture when deciding on death benefit amounts and premium budgets.
- Expected Estate Tax: Estimate future estate taxes based on assets growing and exemption sunset. Optimize insurance needed to sufficiently cover expected liability.
- Insurability: Disclose health issues upfront. Couples with serious conditions may have limited product choices or qualify only for smaller coverage.
- Policy Type: Compare permanent and term options. Look at whole, universal, or variable policies. Assess features like cash value and conversion terms.
- Premiums: Evaluate the ability to continue paying premiums as a single insured after the first death. Some policies offer a waiver of premium features when disabled.
- Timing: Determine when liquidity will be needed – at the first death, second death, or both. This impacts whether individual, first-to-die, or survivorship works best to deliver funds when required.
- Alternatives: Consider the benefits and limitations of other solutions such as self-insuring or living trusts. Weigh survivorship life insurance against supplements or alternatives.
- Taxes: Understand the potential tax implications of various options. Certain strategies like funding irrevocable life insurance trusts require intricate implementation.
Bottom Line
Survivorship life insurance can be an extremely effective way to cover estate taxes and costs while maximizing the assets ultimately transferred to heirs. The joint policy provides ample tax-free liquidity at the second death when funds are most needed.
Survivorship insurance makes the most sense for high-net-worth couples concerned about estate taxes chipping away at their intended legacy. The large death benefit can be utilized without having to liquidate other assets in the estate.
However, survivorship policies are complex with long-term implications. They necessitate evaluating individual factors like assets, goals, health, and taxes to select appropriate policy types and terms.
While survivorship insurance carries advantages, individual policies or alternatives like living trusts may better suit some situations. Couples should carefully weigh options against their specific estate planning needs and resources.
Consulting financial and legal specialists is critical to ensuring survivorship life insurance is properly integrated and positioned to deliver value as part of comprehensive estate planning.
