Survivorship Life Insurance insures two lives in a single contract. Also called 'second-to-die' insurance, it pays the death benefit only after the second person dies. Because of this, its cost is typically lower than two separate policies with the same combined benefit. So who should use a survivorship life insurance – and why?
Traditionally the husband and wife of a wealthy family will contract a survivorship life insurance policy to help pay estate settlement costs and taxes. Federal estate tax law allows unlimited death transfers to surviving spouses avoiding estate taxation of the first-to-die. But this can significantly increase the estate taxation of the survivor's estate at her (second-to-die) death - even for the not-so-wealthy.
Although there is currently a federal estate tax exemption of $5.12 million per person in 2012, thereafter the exemption is scheduled to drop to only $1 million, unless Congress enacts new legislation. Individuals will then be exposed to estate taxation on assets exceeding $1 million in value. So the proceeds from a survivorship policy can be used to pay those costs to keep the couple's assets intact for their beneficiaries.
By the same token, you can also use survivorship life insurance to create a more substantial inheritance for your heirs. Its reasonable cost may allow a couple without significant wealth to buy a survivorship policy with a larger death benefit than otherwise.
Additionally, an otherwise uninsurable individual may still qualify under survivorship policy. That's because the policy only pays a benefit after the second death so the poor health of one party isn't as big a concern to the insurance company as it would be for an individual policy.
Using such a policy, parents can create a pool of money to care for their child with special needs after they're gone. It's essential, though, to arrange for proper ownership and beneficiary designations of the policy to avoid inadvertently disqualifying a child's entitlements.
Survivorship life insurance policies are often owned by irrevocable life insurance trusts which are also named as the beneficiary of the policy proceeds. The provisions of the trust specify how distributions will be made to your heirs. You can make gifts of cash to the trust with which the trustee can pay the insurance premiums.
Unless you've made arrangements for the policy to be paid in full over a specific number of years, the survivor may have to pay premiums after the first death. So, make sure the premiums will remain affordable to the survivor regardless of who dies first.
As always when purchasing any life insurance policy, determine an appropriate death benefit, choose the type of policy that best suits your needs, and have a thorough understanding of the costs, guarantees, cash value, and other factors involved.
Note: The purchase of life insurance involves costs, fees, expenses and potential surrender charges and depends on the health of the applicant. Not all applicants are insurable. If a policy is structured as a modified endowment contract, withdrawals will be subject to tax as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty.