A simple google search reveals reams of digital content about what is known as “second to die” or “survivorship“ life insurance. Articles usually strive to define this type of life insurance in some way, and yet this can be accomplished in one sentence. Simply put, second to die or survivorship life insurance differs from all the other types of life insurance because it insures the lives of two people AND only pays a death benefit upon the death of the last survivor. The more important discussion is how a second to die life insurance policy may be used and when is it most advantageous for the consumer.
One way second to die life insurance can be extremely effective is to fund an Irrevocable Life Insurance Trust a/k/a ILIT as part of a complete estate plan. If you don’t have (or perhaps don’t need) an ILIT, you should still understand how second to die life insurance may strengthen your overall estate planning strategy. Finally, when considering your life insurance options, you should have a brief overview of the most common types of life insurance that offer second to die coverage.
Using Second to Die Life Insurance With an ILIT [for Estate Planning]
Second to die life insurance policies are usually used to protect future generations (usually the children) in the event of the death of BOTH spouses in a marriage. Thus, these policies would NOT be used to protect a surviving spouse. In the same way, an irrevocable life insurance trust (ILIT) is a popular way to protect the children and and grandchildren in the family rather than the spouse who would not benefit from it. So the key purpose of the second to die life policy aligns with the purpose of the ILIT.
Using an ILIT to Protect Future Generations
An ILIT or Irrevocable Life Insurance Trust by definition is an irrevocable trust that is set up to hold life insurance and pay a death benefit to children and/or grandchildren. This type of trust is also known as a wealth replacement trust. Usually, folks set up an ILIT for either estate tax planning OR asset protection or both. ILITs are used for estate tax planning because money can be “gifted” by parents and grandparents into the trust, thereby moving money out of the estate and reducing its taxable exposure. Asset protection is also accomplished because the estate assets are being transferred to an independent trust for the benefit of third parties. This places the assets beyond the reach of the parent or grandparent’s creditors. Upon the death of the insured, the death benefit is then paid to the named beneficiaries of the ILIT.
The IRS allows the gifting benefits without any tax consequences for anyone concerned provided a notice letter called a Crummy Letter is provided to the beneficiaries, to let them know that funds are available. In reality, the beneficiaries will know that withdrawing the funds will have negative consequences for their future inheritance.
How to Set Up an ILIT for Estate Tax Planning and Asset Protection
Typically an ILIT (trust) agreement is drafted by a competent estate planning attorney. An trustee must be selected, who is independent of the parent/grandparent, and the trust should then purchase the life insurance.
Generally, for tax and asset protection purposes, it is better strategy to have the ILIT purchase the life insurance rather than transferring an existing policy to it.
The premium payments can be “gifted” to the ILIT, once formed, and the trustee may use the gifted proceeds to pay the life insurance premiums. At present, $14,000 per year may be “gifted” PER BENEFICIARY without any tax consequences.
Pros and Cons of Using a Second to Die Life Policy With an ILIT
Where a couple is mutually concerned protecting future generation, the second to die life policy is ideal for the ILIT. Usually, this kind of planning involves a married couple with children and/or grandchildren but this approach may also be used by non-traditional couples or those with blended families. The important thing to consider is that the trust will not pay out upon the death of the first partner. The advantage here is that the surviving partner could continue to fund the ILIT and the life insurance through continuing to gift the premiums.
Of course, this kind of plan would depend upon the ongoing financial ability of the spouse AND the ongoing need to take advantage of gifting. Thus, a wealthier couple may benefit more from this strategy. Obviously, for those who would be financially disadvantaged by the death of a partner, life insurance should be used to pay a death benefit to the surviving spouse. This can be done simultaneously, as part of the same estate plan, to thereby enable the surviving spouse to continue gifting to the ILIT.
Other Estate Planning Considerations for Second to Die Life Insurance
Estate Tax Planning
Even if an ILIT isn’t being used as part of the estate plan, perhaps because there are no children or grandchildren, second to die life insurance is a good way to handle the burden of federal estate taxes. As a review, the federal estate tax is a lump sum “wealth tax” or a termed by some “death tax” in the neighborhood of 45% of the gross taxable estate. This lump sum tax generally needs to be paid within 9 months of the estate owner’s death. The good news is there is a federal estate tax exemption amount. So any amount in excess of the exemption is taxable.
That said, the amount of non-taxable transfers of wealth between spouses (who are both U.S. residents) is unlimited, so the estate taxable event occurs upon the death of the last spouse. Thus, the usefulness of a second to die life insurance policy becomes self evident because the payout of a death benefit occurs upon the last spouse’s death.
Family Business Succession Planning
In the same way that a second to die life policy may be used for spousal tax planning, it may also be beneficial as part of a family business succession plan if both spouses are active in a family business. The key question is whether the loss of the first spouse will require a cash infusion to replace him/her. If not, then a second to die policy may be used to fund a buyout of the business by a key employee or third party.
Other Planning for Future Generations
Even if an ILIT is not used to provide for future generations, perhaps because the estate is not outside the non-taxable limits, a second to die life insurance policy may be used in other ways. For example, a second to die policy may provide a death benefit to future generations as part of a revocable living trust distribution plan. This can be accomplished by making the revocable living trust the beneficiary of the second to die policy FBO (for the benefit of) the specified individual beneficiaries.
Types of Second to Die Life Insurance
Generally, most second to die policies are offered either as guaranteed universal life OR indexed universal life policies. The reasoning for this is that these policies typically offer the most design flexibility. Guaranteed universal life is arguably the most popular product for second to die because these policies are set up to offer an inexpensive permanent death benefit, which is a key part of the second to die policy appeal.
Other types of permanent life insurance such as variable universal life, private placement life OR traditional whole life insurance are much more focused on maximized cash value accumulation for various strategies such as infinite banking.
If you’d like to explore a second to die life insurance option OR any other life insurance strategy as part of your estate plan, reach out and connect with us today!
