The nine lives of second-to-die
Second-to-die policies can help with estate taxes, but that’s far from all.
Second-to-die life insurance, also called survivorship life, is most closely associated with the payment of federal estate taxes. In fact, it is accurate to say that such policies were created for that specific purpose.
This is an industry, however, that is hard to match for its imagination in the application of the products that we have to offer. In that regard, here are nine creative uses that have been developed for survivorship policies.
Estate tax liquidity: In the area of tax-oriented estate planning, a husband and wife will typically draft their wills using the bypass trust/marital deduction approach, which postpones all federal estate tax until the second death. Consequently, a life insurance contract is needed that pays the death benefit on the second death when the tax becomes due. A second-to-die contract is perfect for this purpose and is usually purchased though an irrevocable life insurance trust, or ILIT, to prevent the death proceeds from being included in the insured’s gross estate.
Business buy-sell agreements: If a business is owned by a husband and wife and they both intend to stay active until they die, the sale of the business to a new owner should take place on the second death. In such a situation, the husband and wife would enter into a buy-sell agreement with the prospective purchaser, agreeing that the sale would take place upon the second death of the husband and wife. To fund the purchase, the prospective buyer would acquire a second-to-die policy on the husband and wife.
Funding for children with special needs: If two parents have a child with special needs, the greatest risk to the child comes after both parents are dead. To deal with this problem, the parents can establish a special-needs trust funded with a second-to-die policy on the parents. The trust language makes the child a discretionary beneficiary of the trust, which means the child can only receive what the trustee chooses to give the child. Consequently, since the child cannot demand any benefits from the trust, the assets of the trust can not be considered the child’s assets, and the child can not be disqualified from receiving needs-based government benefits, such as Medicaid.
Dynasty trusts: In today’s world, children do not expect to do as well as their parents. This means that, for the first time in American history, the American Dream is gone from the minds of upcoming generations. The result is that, besides educating their children, parents need to start thinking about establishing dynasty trusts to take care of future generations. This is done by having the parents establish an irrevocable life insurance trust funded with a second-to-die policy on the parents. After the parents are both gone, the trust collects the death proceeds and, thereafter, acts as a family bank for generation after generation. As such, the trust can loan money to the descendants to purchase homes or start businesses. It can also provide funds for educational or medical expenses or any other family needs.
Wealth replacement trusts: If parents want to give to a charity, they might be hesitant because they are concerned that their children will resent having a part of their inheritance given away. To solve that problem, the parents can establish an irrevocable life insurance trust funded with a second-to-die policy on their lives. This way, when the parents die, the children will get income and estate tax-free death proceeds from the trust instead of the property that was given to charity.
Spendthrift trusts: Suppose two parents have a child who is not good with money. While the parents are alive, they can support the child, but what happens after both parents are gone? The answer is for the parents to set up a spendthrift trust funded with a second-to-die policy on the parents. After the parents die, the trust will collect the death proceeds, and the trustee will take care of the child’s needs with the funds. Moreover, the child’s creditors will not be able to reach the funds in the trust. Further, to prevent the child’s creditors from taking money placed in the child’s hands, the trustee can purchase goods and services for the child. For example, the trustee can pay the child’s rent directly to the landlord, and the creditors cannot touch the rent money.
Estate equalization: If parents have a business they want to leave to one child but not another, they are faced with a problem when it comes to giving their children equal shares of their estate. The solution to their problem is to purchase a second-to-die policy on their lives and make the child who is not to receive the business the beneficiary. Each child can then receive an equal inheritance. One gets the business, and the other gets an equal amount of life insurance death proceeds.
Financial security: If parents have young children, the greatest risk to the children comes if both parents die. To protect the children from this risk, the parents should establish a revocable trust and make the trust the owner and beneficiary of a second-to-die policy on their lives. Then, if both the parents die, the trust collects the death proceeds, and the trustee provides for the children’s needs.
Clearly, survivorship life insurance policies have multiple uses beyond just paying estate taxes. Moreover, they may be issued even in cases where one of the proposed insured is uninsurable. Further, because the death benefit is not paid until the second death, the coverage tends to be more affordable than single life policies. In any case, second-to-die policies have evolved into a tool with far more uses and benefits to the public than we ever imagined when they were initially designed by our industry.
Guarantees are based on the claims-paying ability of Lincoln Benefit Life Company, Lincoln, Neb., a wholly-owned subsidiary of Allstate Life Insurance Company, Northbrook, Ill.
This information is provided for general educational purposes and is not intended to provide legal, tax or investment advice.
By Louis S. Shuntich, J.D., LL.M. from the December 01, 2012 issue of Life Insurance Selling. Louis S. Shuntich, J.D., LL.M., is senior vice president, Advanced Planning, Lincoln Benefit Life Company, Lincoln, Neb.
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