Second-to-Die Life Insurance: What It Is and How It Works
Explore the essentials of second-to-die life insurance, its structure, eligibility, funding, and tax implications for estate planning.
Second-to-die life insurance, also known as survivorship life insurance, is a policy type that covers two individuals and pays out after the death of the second insured person. It is particularly valuable for estate planning, helping cover estate taxes or providing an inheritance in a tax-efficient manner.
Policy Structure
A second-to-die life insurance policy insures two individuals under one contract, typically structured as whole life or universal life insurance. These policies include a death benefit and a cash value component, which grows tax-deferred and can be accessed through loans or withdrawals, offering liquidity during the policyholders’ lifetime.
Premium payments vary by policy type. Universal life insurance allows for adjustable premiums to accommodate financial changes, while whole life insurance requires fixed premiums for stability. The death benefit is only paid after the second insured individual dies, making it useful for estate tax coverage or legacy planning. Riders, such as those for long-term care or disability, can enhance flexibility.
Eligibility Criteria
Eligibility depends on the age and health of both individuals, assessed through medical exams and history reviews. Applicants typically need to be at least 18 years old, with a maximum age limit of around 85. Health affects both eligibility and cost, with healthier applicants receiving more favorable terms.
Financial stability is also evaluated, as insurers assess income, assets, and liabilities to ensure the couple can sustain premium payments. These policies often align with estate planning goals, addressing estate tax liabilities or providing for heirs.
Funding Arrangements
Funding for second-to-die life insurance often integrates with broader financial strategies. Irrevocable life insurance trusts (ILITs) are commonly used to shield the death benefit from estate taxes, ensuring funds are available for estate obligations or beneficiaries. ILITs also provide asset protection by removing the policy from the taxable estate. Legal and tax professionals should be consulted to ensure compliance with relevant regulations.
Premium financing is another option, particularly for high-net-worth individuals aiming to preserve liquidity. This involves borrowing funds to pay premiums, using the policy as collateral. While this conserves cash flow, it introduces risks, such as interest rate changes and loan repayment obligations, requiring careful evaluation of financing terms.
Disbursement Procedures
After the death of the second insured individual, the insurance company disburses the death benefit to beneficiaries. This requires a claim submission with a death certificate and supporting documentation. Beneficiaries should familiarize themselves with policy details to expedite the process.
The death benefit can be received as a lump sum or through structured settlements, which distribute payments over time. Structured settlements provide predictable cash flows and may reduce tax implications. Each option has financial and tax considerations that require careful analysis.
Tax Factors
Tax implications are critical for second-to-die life insurance, especially in estate planning. The death benefit is generally income-tax-free under Internal Revenue Code Section 101(a). However, estate tax treatment depends on policy ownership. If the policy is owned by the insured individual at death, the benefit may be included in the taxable estate and subject to federal estate taxes, which in 2023 apply to estates exceeding $12.92 million for individuals or $25.84 million for married couples.
Transferring the policy to an ILIT can exclude the death benefit from the taxable estate, provided it adheres to the three-year lookback rule under IRC Section 2035. Gifting strategies can fund the ILIT, utilizing the 2023 annual gift tax exclusion of $17,000 per recipient.
State-level taxes may also apply, as some states impose estate or inheritance taxes with lower exemption thresholds than the federal level. For example, states like Massachusetts or Oregon cap estate tax exemptions at $1 million. Second-to-die policies can provide liquidity for these tax obligations, preserving other estate assets. Working with tax advisors and estate planning attorneys is essential to tailor the policy structure and funding to specific tax landscapes.