Pros and Cons of Second to Die Life Insurance
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There are a lot of pros and cons that come with second to die life insurance.
However, before getting to the upsides and downsides of this policy, it is essential first to understand what it is and how it works.
While the concepts of second to die insurance contracts may sound complicated at first, they are quite easy to figure out.
What is a Second to Die Life Insurance Contract?
The policy is a joint contract where compensation is paid only after the last surviving person dies. It is also known as survivorship life insurance. This type of insurance is typically taken mostly by married couples.
However, the policies can have more than two people within the contract. Sometimes a group of people, say 4, may take up such insurance and the compensation will be paid out to the listed beneficiaries after the last person passes away.
Employees or friends can also take this type of policy if they share a common interest.
The history of this type of insurance stems down from the 1980s. During the time, a new law was established that delayed federal estate taxes until both partners died. The law was enacted to spare surviving spouses from large tax bills that would have depleted their finances.
However, as soon as the spouses or couple died, if they left their wealth as an inheritance to their children, the government would levy taxes. These high taxes prompted people to start using survivorship as an alternative means of mitigating those taxes.
Over the past decade, rates for the policy have dropped significantly from 6-12% during the 90s to 3-4% in the 21st century.
How it Works
One of the features that distinguish this type of insurance from other policies is that the surviving partner does not gain any benefits from it. This form of insurance appeals mostly to couples with a lot of assets who want to protect that wealth during its transfer to their children.
The insurance begins with an annual premium covering the death benefit. Excess payment builds cash value and goes on to cover some or all of the increased premiums you pay as you age.
The catch with this form of insurance is that once you buy it, it is difficult to cancel it and gain any benefits when one of the partners walks out.
However, if you can manage to keep paying the previous premiums, then the contract continues to remain valid.
Who Needs This Policy?
Survivorship life insurance can be a significant asset to the following:
- Families with a high net worth that will experience hefty estate taxes during inheritance. Wealthy families will want to transfer their assets and riches to their children while retaining as much of it as they can and not losing it to taxes.
- Business owners who want to save their business from liquidation after they die – To avoid a need for assets to be liquidated for cash, this insurance can be used to stock money that will be used for that purpose in the future upon the death of the insured.
- Investors whose wealth is tied up in income-generating assets.
- People who want to pass on their legacy through charities.
- Those who wish to their insurance benefits to go straight to the beneficiaries and not their spouses. If you are uncertain about leaving death benefits to a spouse, then second to die insurance gives you an opportunity to make sure only the kids will benefit from the policy.
- Couples who want a cheaper alternative to individual life insurance policies – This policy spreads risk across partners and thus enjoys more affordable premiums.
The Pros of Second to Die Life Insurance Policy
There are a lot of advantages that come with buying a second to die life policy. Since its inception, spouses have used it mostly to minimize the amount in taxes charged during wealth inheritance.
Parents take up this policy with the intention of protecting their children from the burden of death taxes. However, tax loopholes aren’t the only upside to this policy.
Survivorship policy can be a means of building up substantial wealth since it reduces risk, and the rewards can be remarkable. There are many more benefits to gain, as explained further below.
The policies are cheaper than taking up individual life policies for any couple. It almost always results in more affordable premiums.
This is because insurance companies face less risk of death when both spouses are involved. Because of the reduced risk, the insurance company charges fewer premiums for the policy.
Let’s use an example to make it more clear
Consider a couple just under 70 years with individual whole life policies where they are paying premiums of $60,000 and $80,000 annually. These are high premiums, but they most likely going to die within the next twenty years.
If they each have a guaranteed death benefit of $3 million, then that puts the total payout at $6 million to their children when they die. However, they are paying a whopping $140,000 each year; a figure very few can manage.
If the couple took life insurance for $3 million, their annual premium would be roughly $50,000. This is a significantly reduced amount that not only saves money but gives them a notable death benefit to leave their children.
The children can also help in paying the premiums, and even in a span of 20 years, they would still acquire remarkable gains from the death benefit.
Ease of Application
As stated earlier, because of the fact that two lives are involved, there is less risk for the insurance company. They, therefore, tend to go easy on the applicants for the policy.
A life insurance underwriting process refers to the procedure used to determine whether you qualify for an insurance or not. While in some types of life insurance, they can be thorough, the process is usually more straightforward with survivorship insurance.
During the underwriting, the insurance company mainly focuses on the youngest and healthiest of the two applicants. Age is a significant factor in calculations of the premiums to be paid. And in survivorship insurance, they calculate premiums using an average age of the couple.
Cover People with Medical Conditions
Getting an insurance policy if you have chronic illnesses or terminal medical conditions is one of the most challenging processes ever. Most insurance companies will deny you the policy because they consider you a very high risk.
However, with survivorship insurance, those who are considered uninsurable can finally have a chance of securing a life insurance policy.
With a partner, your risks become spread, and since the insurance company leans more on the healthier partner, your chances of getting a cover increase significantly. Your spouse, therefore, acts as a balance neutralizing the risks your health condition poses to the insurer.
Even when you do manage to secure a life policy, severe medical issues also increase the premiums you pay for life insurance. With a policy, those premiums will be far much less in comparison.
Provides Estate Security
The federal government has a limit on the value of family estates that can be transferred to heirs without taxation. The current value is at 11.4 million dollars. If the estate has a higher cost, then the heirs to it will have to pay 40% in inheritance taxes. In some cases, the tax rates have been as high as 55%.
Second to die policy provides a loophole that can be used to reduce the impact of these tax rates during wealth transfer. There are several ways through which survivorship insurance provides estate security.
The estate tax can significantly impact the net worth of the estate as a whole. Its stability may be shaken due to the need for its liquidity in order to get the money for paying the taxes. A survivorship policy can be purchased; one which will yield a death benefit large enough to cover the estate taxes and prevent its liquidation.
To avoid or mitigate inheritance taxes, wealthy families will purchase a second to die plan through an Irrevocable Life Insurance Trust. The heirs of the family wealth get the typical rights that come with a family trust.
When the spouses die, the insurance company pays out the benefits to the family trust. This ensures that the payout is not considered part of the estate, and hence, it cannot be taxed.
The lump-sum payout will then act as liquidity that will be used in paying the estate taxes, thus preventing any sale of assets to raise money.
Can Be Used in Building an Estate
Sometimes families can use life insurance in creating an estate for the children to inherit when the parents die. In some cases, the children can liaise with the parents where they take up the policy, and then they pay the premiums together.
Alternatively, other parents may decide to go for a single premium policy.
Single-Premium Survivorship Insurance
This type of insurance offers one of the best and guaranteed returns. The couple or spouses pay one substantial lump-sum premium, and their children in return get a guaranteed significant payout when they die.
The advantage of this arrangement is that you will never have to worry about premiums again for the rest of your life. Moreover, the policy will never lapse due to unpaid premiums.
The beneficiaries of the death benefits can also use part of the proceeds to secure the future of their children in return. All they have to do is simply take around 30% of it and use the money to buy another single premium survivorship insurance.
If the policy is bought while they are still adults and young when they die the payout to the beneficiaries will be even higher. This way, families can map out a strategy for increasing the proceeds given out to each generation.
Promotion of Equality in Inheritance Succession
While not commonly used as a reason for getting survivorship insurance, this policy can come in handy in splitting assets across children when the parents die.
If the parents want to leave one of their children in charge of the assets, they can use this policy to guarantee the other children also get an inheritance. The payout will be their inheritance.
Using this tactic prevents heirs from splitting the family estate or selling it off to break the returns. It ensures the family name is kept alive through another generation.
The children also get to enjoy the privilege of being recompensed as heirs based on their interests.
Security for a Child with Special Needs
If you have a child with special needs who relies on you, the parents, then it would be wise to consider a second-to-die contract. The death benefits that come with it will be used in taking care of the child and providing for his/her needs.
It is also advantageous because you can rest easy knowing that your spouse will not have access to that money, and it will only be kept for the child.
The best way to go about it is by setting up a trust that will take up the policy. Therefore, the proceeds of the death benefit will not be taxed. A trust will also ensure that the policy does not interfere or change any benefits that your child enjoys from the government.
Preservation of an Inheritance Left for Charity
If you want to leave a legacy behind through a charity or by making a lump sum donation, then survivorship insurance can help you do just that. Having spent your life making donations to various charity projects and organizations, perhaps you may harbor a desire to do one last deed.
The second-to-die policy gives you an opportunity to donate your proceeds to a charity of your choice and avoid estate taxes. Since donations are considered gifts, they will also be taxed at the same rate as inheritance wealth, which is 40%.
Just as high net worth families use this insurance policy to mitigate taxes, so can you when leaving behind a fortune for charitable endeavors.
Multiple Rider Options
Most insurance companies will offer optional riders along with the survivorship insurance. There are several types of riders, and they can be very beneficial to the insureds. It is advisable to consider them and decide on which ones are worth adding to your policy.
Although these riders attract additional costs to the premium, the benefits they add far outweigh these charges. Let us take a look at four of the most common riders.
Accidental Death Rider
It is also referred to as the double indemnity rider. This rider offers to double the amount of payout if you die due to an accident. The policy will most likely have an expiration date for the coverage, but it is still a noteworthy option to consider.
Before taking up this rider to your policy, ensure you thoroughly read and understand the insurance company’s definition of accidental, which is usually restricted.
Waiver of Premium Rider
This rider, on the other hand, excludes you from paying premiums if you become disabled when you are 65 years or older. Any premiums that you pay during the period you were disabled will also be refunded to you.
However, once you are back in good health, you will be expected to continue paying your premiums. Once again, ensure you are fully aware of what your insurance policy defines and considers ‘disabled.’
Renewal Provision Rider
Also referred to as guaranteed insurability, this rider applies to policyholders who opt to go for a survivorship policy under term insurance. The rider guarantees you of policy renewal upon the expiry of the term.
If you decide to renew it, then the contract continues being active without the need for another underwriting. Since this rider may have an expiration once you reach a certain age, make sure you get its full details.
Family Income Benefit Rider
Adding this rider to your policy guarantees your family will receive your monthly earnings after you die. The rider is often used by families that have only one source of income. It serves as an alternative so that the family members left behind continue to have a means of support.
During its application, you will be required to state the length of time you want your family to continue receiving the income. The longer the duration, the higher the premiums you will pay.
The income payments will also decrease with time until they eventually stop. The idea is usually to give your family a grace period to find alternative sources of income so that when the income payments run out, they will be supporting themselves.
Second, to die life insurance policies can also feature a ‘spendthrift clause.’ It is mostly done using an irrevocable trust. What it does is that it controls the spending of the beneficiary and prevents them from exhausting all the death payout.
This feature comes in handy when parents want to protect a child with special needs or one who is financially incautious.
Arrangements can also be made where the trustees of the trust make periodic payments to the beneficiary instead of merely giving them a lump sum of the death benefit at once.
Spendthrift clauses prevent your beneficiaries from overspending and keep the money in the trust safe from creditors. Appointed trustees can also pay the beneficiaries bills directly without giving them money. This will provide you with peace of mind as a parent knowing that your child will be well taken care of.
The Cons of Second to Die Life Insurance Policy
Although the advantages of the survivorship insurance policy are plausible, it also comes with its downsides. These cons are given further insight into the section below.
Benefits are Paid Only after the Death of the Second Person
This is the major con of this type of life insurance. None of the insured will ever enjoy the benefits of the insurance even when one of you dies.
Survivorship insurance cannot be used as an income safeguard for when one of the spouses dies.
Additionally, the premiums could also be a burden to the partner left behind. If both spouses were contributing toward paying the premium, the second one to die could have a rough time if they had not planned on how the premiums will be paid when one of them dies.
Most couples do not take up this form of insurance because it provides no benefits to the partner when one of them dies.
It is also noteworthy to mention that permanent life insurance can be sold to save them from lapsing. If managing the premiums becomes difficult, the spouse who is still alive can sell the insurance through viatical settlements. This option is usually more rewarding than the cash surrender value the insurer is willing to offer.
Subject to Marital Changes
Most couples plan to stay together until death. However, life changes, spouses split up, and marriages break. What you should know is that these changes do not change the terms of agreement of the policy.
Even when a couple decides to get a divorce, the policy continues to remain active until they default on the premiums. It would be quite a loss if, after a decade of paying the premiums, the insureds let it lapse.
Parents can agree to continue paying the premiums, but sometimes this situation is affected if the new partners of the insureds do not want the arrangement to continue. Nonetheless, the policy can always be sold, as I mentioned earlier.
There is No Cash Value
Unlike cash value life insurance, this type of policy does not focus on cash value addition but instead offers the largest death payout possible. Which is pretty awesome.
However, cash value life insurance can help you in increasing your wealth profoundly. The idea is to choose an insurance policy based on what your goals are. But if you can, diversify your portfolio.
The Policy Cannot Be Altered
It does not leave room for making any changes once they come into effect. This means you cannot renegotiate the terms or requests for additions to it.
Therefore, the death of your partner, a separation or divorce does not warranty changes in the premiums paid or terms of the policy.
Due to the nature of the contract, it is essential to take time and consider all its aspects before purchasing it. Most importantly assess if you will be able to keep paying the premiums on your own if your partner no longer can.
As you have seen, trusts make up a vital part of the second to die policy. This is because they act as the protective barrier that shields your assets from taxation when you die. In light of that, here are a few dos and don’ts when it comes to setting your trust.
Establish an Irrevocable Trust
When establishing a trust, ensure it is an irrevocable trust. A revocable trust is one that can be controlled by the establisher. These kinds of trusts are considered as assets by the IRS, and they will count as part of the estate to be taxed when you die. This means that even your second to die policy death benefit will be taxed.
An irrevocable trust, on the other hand, is controlled by an appointed trustee. This trust cannot be changed or altered once it is set up. The appointed trustee will manage the trust based on the set terms.
When appointing a trustee, it is crucial you choose someone you can trust and one who will carry out your wishes. This will ensure that you control where your money ends up, and it will also give you peace of mind knowing you are leaving it in trustworthy hands.
A trustee can be a relative, a lawyer, or a bank executive.
Term Insurance is a NO
Term insurance tends to be an attractive option due to its lower premiums. However, statistics show that most of them expire before the insureds turn over 80. Since they don’t provide lifetime coverage, it opens you to the risk of outliving them.
If you are going to fund a trust, then make sure you get an insurance policy that will guarantee a death payout when you die.
Age in Survivorship Life Insurance
As with any insurance company and policy, age goes a long way in influencing life insurance policies. And in the same way, it affects survivorship insurance.
During underwriting, the average age of the insureds is used to determine the premiums they will pay. This means if one person is 65 and the other 73, then 69 is the age that will be used.
This comes with advantages and disadvantages for the partners. For instance, the younger partner would have paid fewer premiums but now has to pay higher premiums due to the increased years. However, the older partner enjoys fewer premiums since he/she would have paid higher premiums.
Tips for Shopping for a Survivorship Policy
There are specific points to factor in when buying for a life policy. Here are several tips to consider.
Selecting an Agent
A lot of agents have never worked with second to die policies. Such agents will most likely not have developed carrier relationships, and therefore getting you the best policy will be difficult.
When working with an agent, go for those who have years of experience in the field, and they are familiar with the procedures of the policy. Such agents will get you better quotes from insurers.
There are several types of permanent second to die policies such as:
- Survivorship universal life: This policy offers cash value and the room to change the premium and death benefits. It can be useful since it will let you redraw your policy based on your financial tuning with the coming years.
- Survivorship variable life: The cash value of this insurance gets invested by the insurance company.
- Second to die whole life insurance: This is a permanent policy that runs throughout the insureds’ lives. They will be expected to pay premiums until they die if the policy is to remain valid.
During your shopping, compare the premium rates for these types of policies to see the one that suits you best. The best one to go for is one that guarantees a death benefit since that is what you are after.
Guaranteed premiums also help keep premiums in check. This will prevent your premiums from going up when the cost of insurance increases or the interest rates reduce.
Choose a Reputable Company
Companies with stable finances will exist even after you are gone. You need an insurance company that you can rest assured will pay out the death benefit when you die.
There are agencies that rank insurance providers based on their financial strengths. These rankings can be used to assess the stability of the company which directly influences their ability to pay out claims.
Here is a list of some of the companies in America that offer second to die life policies and have a fantastic rating on their performance.
- American General
- John Hancock
- Lincoln Financial
- Mass Mutual
- Mutual of Omaha
- Pacific Life
- Principal Financial
- Protective Life
The second to die life insurance is not the most ideal in a lot of situations. This is especially so if the family is relying on income from one spouse. However, if you are a high-end family with a net worth of more than $11.2 million, then you ought to consider it.
It is ideal when you want to establish a trust, mitigate estate taxes, divide an estate among your children or donate your money to a charity upon your death.