How many people are willing to buy life insurance that might not pay off when they die? Turns out quite a few, according to insurance industry experts. And many times it’s a good idea.
Survivorship insurance, also known as second-to-die insurance, is written not against the life of one person, but on two people. Only after the second person dies does the policy pay.
The primary use for survivorship insurance: taxes. In most cases, an estate passes tax-free from one spouse to another. Only when the surviving spouse dies does Uncle Sam send the bill. So, many couples use second-to-die policies as part of their estate planning.
“I would say that 90 percent of the second-to-die policies we see are principally purchased for cash to pay estate taxes,” says Steve McDaniel, partner with Williams, McDaniel, Wolfe & Womack, PC, a Memphis, Tenn.-based law firm that specializes in estate planning.
Even when one spouse is very sick, the chance of two people dying in tandem is slender. As a result, a second-to-die policy is probably cheaper than two separate policies. And it might be a good option when one spouse has health problems.
“I’ve seen it used where one of a couple is not insurable or is difficult to insure,” says Don Wright, chair of financial gerontology at the American College in Bryn Mawr, Pa.
Protect the business
Survivorship is also used to protect business partnerships. Often, business partners will agree to buy a deceased partner’s interest from the heirs. The money to buy out one partner may be easy enough to acquire. But what if several of the partners die in quick succession?
McDaniel, who serves as secretary for the National Association of Estate Planners and Councils, remembers one instance when two of three partners in an agriculture concern died in a plane crash.
“The surviving partner in the business ended up in bankruptcy because he couldn’t stay in business and pay the widows,” McDaniel says.
Business partners can use several second-to-die policies, covering various combinations of partners. Or they may find an insurer that would custom tailor a policy to their particular needs.
“There are some companies that would create a specific policy or combination of policies for a specific business,” says Jack Dolan, spokesman for the American Council of Life Insurers an industry group based in Washington, D.C. “It would be a specially tailored product to meet a specific need.”
Do your homework
Consumers need to ask some questions before they buy.
- What’s the insuring company behind the policy, what is that company’s track record with these policies and how stable is the company? You can also check the company’s rating with industry-rating firms like A.M. Best Company.
- Who is the person selling the policy to you? What is his or her training? Is that person certified in tax, financial or insurance planning? And how is the person compensated? “You’ve got to be a little more careful evaluating the knowledge of someone who doesn’t do this for a living,” says Wright, a CPA and attorney who owns Wright Consultants, PC, a Bryn Mawr, Pa.-based financial planning firm.
- What’s the price and what are you buying for that price? In insurance, cheaper is not necessarily better, so look carefully at the details and be certain you have the right product for your situation. “My biggest part of any insurance [transaction] is have I got the right fit?” says Wright.
- What kind of insurance are you buying — term, whole life, variable, universal or a hybrid of several types? Different products will have pluses and minuses. Look at them carefully and understand the finer points of how they work before you buy.
It’s a complicated topic. Don’t feel dense if you don’t understand the terms being thrown at you. Ask questions, do some outside reading (via the Internet, the bookstore or the library) and don’t be afraid to ask other independent pros for a second opinion.
Changing tax laws
No matter how well you plan, life — and the U.S. Congress — might just throw you a curve. What if you buy a survivorship policy to cover your estate taxes and the estate-tax system is discontinued?
“One of the debates today is, do you believe the estate tax will disappear in 10 years?” says Wright. “If you believe in that, you ought to look under the pillow tonight because the Tooth Fairy will be there.”
But if you’ve prepared for a tax that doesn’t come, you still have options, says David L. Mellem, an enrolled agent, the research manager with the National Association of Tax Professionals. You can either cancel the insurance or, in many cases, convert it to another type of policy. But if you cancel, unless the policy has built up a cash value, you will lose the money you’ve been putting in over the years, he says.
Mellem’s advice: If you’re buying second-to-die for tax purposes, get your financial planner and tax preparer in a room together and make sure the idea passes muster with both.
Wright believes that’s a sound idea, provided the consumer is not present at the meeting. Otherwise, he says, a “room full of very large egos” could get in the way of good sense.
Instead, he suggests choosing the pro you trust most and asking them to act as “point-person” in the discussion. That way, he says, you get the full evaluation minus the drama.
And in some cases, when the policy has nothing to do with taxes, the issue is moot.
One couple McDaniel serves doesn’t have an estate-tax problem. They have their financial future planned and also have long-term care insurance and a living will. Instead, they bought a survivorship policy to serve as “the inheritance,” for their grown kids, he recalls.
“They said, ‘We can spend what we want through wild living. We’re going to enjoy life.'”
Says McDaniel, “It’s a unique position to take, but it makes sense.”