A Complete Guide to How Survivorship Life Insurance Works in Estate Planning
Estate planning is an essential part of the financial planning and asset protection process, and life insurance is a crucial component of any estate plan. Survivorship life insurance is one type of joint life insurance policy that is particularly helpful for estate planning. However, you might struggle to navigate your options with the numerous plans and insurance types available.
So how are survivorship life insurance policies helpful in estate planning? To help you out, this article will discuss how survivorship life insurance policies can be a helpful tool in estate planning with a comprehensive guide on the different types of life insurance, how survivorship life insurance works, and the advantages of life insurance for estate planning.
What is Survivorship Life Insurance?
Survivorship life insurance is a joint policy that covers two people and pays out a death benefit to the surviving beneficiary when both policyholders have passed away. Also referred to as a second-to-die policy, survivorship life insurance only becomes accessible to beneficiaries when the second policyholder passes away, unlike other joint policies like a first-to-die option.
Middle- or high-net-worth families typically use survival life insurance policies to safely transfer their assets to beneficiaries after passing. Beneficiaries are often family members, such as children, when the policyholders want to name a successor, transfer costly assets, or create a trust for the beneficiary.
Types of Joint Life Insurance
Several types of life insurance can be used for estate planning. The two types of joint life insurance include first-to-die life insurance and second-to-die life insurance, more commonly called survivorship insurance.
A first-to-die policy is a joint life insurance policy that pays out a death benefit. Married couples can access this policy when the first insured person dies. This policy can provide needed financial security for the surviving partner, who may struggle to make ends meet without the deceased’s income.
The primary advantage of a first-to-die policy is that it can provide financial security to the surviving partner in the event of the first partner’s death. The death benefit could be used to pay off debts, cover living expenses, or even take a vacation.
The primary disadvantage of a first-to-die policy is that the coverage won’t always provide flexible options in the event of a divorce or separation, making it risky for many couples.
A second-to-die policy (also known as a survivorship policy) is a joint life insurance policy that pays a death benefit when both policyholders pass away. Second-to-die policies have numerous benefits and are cheaper than separate, individual insurance policies. For estate planning purposes, a second-to-die policy can leave money and assets to beneficiaries and allows beneficiaries to access specific tax advantages. Additionally, some of the benefits of a joint survivorship insurance policy include the following:
- Offers care to the policyholder’s permanent dependants
- Allows policyholders to leave an inheritance for their heirs, such as children
- Simplifies the process of qualifying for life insurance due to health, age, or other factors, allowing a partner to receive coverage that they may struggle to otherwise.
- The surviving spouse can still use the policy’s cash value if necessary if their spouse dies, though the death benefit is not paid until both parties have passed away.
Though the benefits of survivorship policies make them an attractive option for many couples, there are specific disadvantages to this joint policy. For instance, the following might make you reconsider whether a second-to-die policy suits your situation.
- Only one death benefit is available with this policy, making it unsuitable for couples that can comfortably afford two separate insurance policies.
- This policy doesn’t allow your partner to be a beneficiary, which will not help the surviving spouse pay estate taxes.
- Like the first-to-die policy, survivorship insurance is complicated in the case of divorce or separation, and the policyholders may not be able to split the policy in this situation.
How Survivorship Life Insurance Works
Survivorship life insurance provides a death benefit to the surviving beneficiaries upon the passing of both insured policyholders. The death benefit is used to pay for the expenses associated with the deceased person’s estate, such as taxes, funeral costs, and other debts.
The beneficiaries then receive the balance of the death benefit, which can be used to cover some of the following expenses:
- Living expenses
- Paying off debt
- Funding a functional needs trust
- Business succession planning
- Estate planning strategies
Survivorship Insurance Policies for Estate Planning Strategies
Survivorship life insurance policies are used for estate planning strategies for middle or high-net-worth couples with children. These policies can help the children or other beneficiaries pay off the estate tax burden after the policyholders both pass away.
A survivorship policy is crucial because if the resulting assets of both policyholders exceed the current federal exemption level, federal estate tax responsibilities fall on the shoulders of the beneficiaries. Survivorship insurance policies offer immediate cash flow to help beneficiaries pay expensive estate taxes and any additional costs after the policyholders pass away.
Advantages of Survivorship Life Insurance
Survivorship life insurance can be a helpful estate planning tool, and survivorship life insurance policies can provide extra financial security to beneficiaries. While this policy is helpful for estate planning strategies, there are other benefits of a joint survivorship policy, such as the following:
- Avoiding Federal Estate Tax: Survivorship life insurance policies can help avoid the federal estate tax imposed on estates with high net worth. When the death benefit from the policy is paid out to the beneficiary, it is not subject to federal estate tax. It can be used to pay any other due debts to ensure that the estate’s beneficiary is not left with a significant tax burden that needs to be paid before they can access the estate’s remaining assets.
- Functional Needs Trust: Survivorship life insurance policies can also fund a functional needs trust for a family member. This trust can provide for the medical care of the deceased’s family members following the passing of both insured parties. The death benefit from the survivorship life insurance policy can fund the trust, which can be used to pay for medical expenses, living expenses, and other necessary costs that a special-needs beneficiary may have.
- Medical Issues Workaround: Second-to-die policies are helpful because they provide coverage for spouses that cannot afford individual life insurance. This option is a popular policy for couples where one partner is in good health, and the other has specific medical concerns.
- Business planning strategies: Joint survivorship policies are helpful when the policyholders need to plan a business succession strategy. Beneficiaries might include a business partner or child heirs who will take over the business in the future.
- Charitable donations: Some policyholders use survivorship policies to maintain a legacy and donate assets to a charity after both policyholders pass away.
Other Types of Life Insurance to Consider
Survivorship life insurance policies are not suitable for everyone, and depending on your circumstances, you may want to consider another option. Specifically, term and permanent life insurance can offer unique benefits to help you find the best plan.
Term Life Insurance
Term life insurance is an insurance policy offering coverage for a specified period. It is also known as pure life insurance because it does not have a cash value component attached, unlike permanent life insurance. This factor means it is not an investment and does not accumulate cash value. If the policyholder outlives their term life insurance policy, their coverage will end, leaving you with a few limited options:
- Converting your policy to a permanent life insurance policy
- Selecting a new insurance policy
- Going without insurance coverage.
However, term life insurance can benefit many policyholders, especially if you think you will only need coverage for a specific period. Individual life insurance policies like term life insurance ensure that your partner is taken care of if you pass away and is typically cheaper than a permanent policy.
Permanent Life Insurance
Permanent life insurance is an insurance policy that provides coverage for the insured person’s entire life as long as the policyholder pays premiums. This policy is sometimes known as a universal life insurance policy. The premiums for permanent life insurance tax law are typically higher than those for term life insurance, making this a more expensive option than term life insurance. However, a permanent policy lets you build cash value, unlike term policies.
Additionally, permanent life insurance policyholders can add insurance riders to their plans to offer more protection in case of a potential illness or untimely death. This factor is helpful for any policyholders that want to incur a cash value for beneficiaries.
Start Planning an Insurance Policy Today
A survivorship life insurance policy can benefit many couples seeking an effective estate planning tool. By providing a death benefit to beneficiaries, survivorship insurance can pay for crucial costs related to paying estate taxes. However, this policy isn’t suitable for everyone, and your decision should be based on advice from an attorney, financial advisor, insurance company, or certified public accountant.