Survivorship Life Insurance

Survivorship life insurance, which is also known as “second to die” insurance, is a specific type of life insurance policy that is primarily used for estate planning purposes. The primary function is to offset taxes due on an estate that passes from a parent to a child or children. A married couple may have a survivorship policy so that surviving children are able to pay inheritance taxes without having to liquidate assets. A self-employed individual or small business owner may also purchase this type of policy so that the business need not be sold upon the death of the owner to pay taxes.

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Survivorship Insurance Basics

Survivorship life insurance is a joint policy that insures two people but only pays a death benefit upon the death of the second person. It can be set-up with a husband and wife or with two business partners. A survivorship policy can be structured as a whole life, universal life or variable life policy. This kind of permanent insurance will build additional cash value over a period of time and provided for a larger benefit upon the death of the second insured. The premiums must be paid as indicated in the contract in order for the policy to remain in force throughout the life of the second insured.

The premiums for a survivorship life insurance policy are based on the ages and health histories of each of the applicants, whether the policy is prepared for a husband and wife or business partners. Because two sets of actuarial tables are used, the premiums will differ from those of a standard individual policy. However, because it is technically one policy, it may be less expensive than buying two separate policies. And, if one member of the couple is harder to insure, or if he or she is unable to obtain an individual policy due to a health condition, a survivorship policy will more than likely cover both of them, as the healthy member of the couple will offset the less healthy one.

The Benefits of a Survivorship Life Insurance Policy

In 1981, the United States Congress passed the Economic Recovery Tax Act. This allowed assets to pass from one spouse to another without taxes being assessed on the estate until the death of the second spouse. This has become known as the unlimited marital deduction. Once the second spouse dies, however, the beneficiaries of the estate are required to pay taxes on all of the assets. For some families, this can be a substantial amount of wealth. And, while a certain portion of the estate may be exempt from inheritance taxes, in certain cases, the amount of the taxable estate can be significant.

Because the death benefit paid on survivorship insurance is almost always tax-free, this type of policy became an important way for beneficiaries to raise cash in order to satisfy the tax payments without having to sell inherited assets potentially reduced rates. Since inheritance and estate taxes are normally due within 9 months of the death of the second parent, this prevents the beneficiaries from having to liquidate potentially illiquid assets like property quickly.

For those interested in providing assets to a charity along with leaving a portion of the estate to a child or children, a charitable remainder trust (CRT) allows for the sale of an appreciated asset, which could be stock, property, a business, etc. without having to pay capital gains taxes. By having a survivorship life insurance policy, the actual assets can be passed to the charity at the time of death while the proceeds of the survivorship policy are paid to the heirs. This in effect reduces the value of the estate to zero, which means inheritance taxes will normally not be due. The most common way to prepare a charitable remainder trust is to make sure the survivorship policy equals the value of the asset or assets that will be given to the charity.

Preventing Tax Erosion with Survivorship Life Insurance

Sometimes, a family owned business is the most vulnerable asset to inheritance taxes. A husband and wife can work for decades to build a successful business only to have it liquidated by the heirs in order to pay inheritance taxes. Because some couples have the bulk of their estate in the business, the entire business, including any property may have to be sold in order to satisfy tax requirements. Or, if not all of the couple’s children are involved in the business, the distribution of assets may not be equal.

A survivorship life insurance policy could not only prevent the liquidation of the business, but could also ensure that all of the children received an equal amount. In other words, the business and a portion of the proceeds of the survivorship policy could be left to one child while the balance of the policy is left to another child.

Another area of wealth accumulation that is very vulnerable to estate taxes is retirement savings accounts such as 401(k) and other tax-qualified plans. These plans grow tax-deferred, often over decades, and can become a person’s largest asset, often exceeding the value of property. Taxes are not paid until distributions begin and only a portion of the amount of the distribution is taxed.

The beneficiary of an estate that has a retirement plan, however, could be responsible for ordinary income tax on the distribution along with an estate tax. In other words, the amount of the qualified plan that is left to the beneficiary will be quickly eroded by taxes. In some cases, up to 70% of a retirement plan can be taken in taxes, depending on the amount of the plan and the tax bracket of the heir.

Finally, survivorship life insurance can also be used between business partners in order to make sure that the surviving partner has enough cash to buy out the other’s share upon his or her death. A buy-sell agreement funded with a life insurance policy would provide a tax-free death benefit that would cover all expenses and taxes due upon the death of the second partner.

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