How Are Survivorship Life Insurance Policies Helpful in Estate Planning?
One of the biggest shifts in estate planning happens so gradually that many couples don't even notice it. Early on, the concern is protecting each other. Once that part of the plan is in place later on, the focus turns to protecting the family, the legacy, and the wealth you'll eventually leave behind.
Survivorship life insurance was built with that second conversation in mind. This guide explains how it works, the estate planning challenges it can help address, and what to consider before deciding whether it belongs in your estate plan.
How Survivorship Life Insurance Works
Survivorship life insurance is a type of life insurance policy that covers two people under a single policy. The insurer pays the death benefit only after both insured individuals have passed away. For this reason, you may also hear it called second-to-die or last-to-die life insurance.
The timing of that payout, which often coincides with the transfer of a couple's remaining wealth to the next generation, is precisely what can make it useful in estate planning.
Unlike a traditional life insurance policy, which is designed to provide financial support immediately after one spouse dies, a survivorship policy delays the death benefit until the point when heirs are more likely to inherit the estate.
The death benefit can provide a lump sum to heirs when hefty estate taxes, debts, settlement costs, or other expenses may come due. This eliminates or reduces the need to sell assets the family would rather keep, such as a business, farm, or investment property.
In other words, it provides much-needed liquidity at a time when the estate may have substantial financial obligations but relatively little cash.
As you can probably tell, this type of policy is most appropriate when the surviving spouse doesn't depend on the death benefit for immediate financial support after the first spouse's death. Its primary purpose is to provide beneficiaries with financial support after both spouses have died.
Survivorship coverage is usually structured as permanent life insurance, which is designed to remain in force for life as long as premiums are paid and the policy's requirements are met.
Survivorship Life Insurance vs. Individual Life Insurance
Both survivorship and individual life insurance provide a death benefit, but they're designed to solve different estate planning and financial goals.
Aspect | Individual Life Insurance | Survivorship Life Insurance |
Who is insured? | One person | Two people under a single policy |
When is the death benefit paid? | After the insured person dies | After both insured individuals have died |
Primary purpose | Replace lost income and protect surviving family members | Preserve wealth and support estate and legacy planning |
Who typically benefits? | The surviving spouse, children, or other financially dependent beneficiaries | Heirs, trusts, charities, or other beneficiaries inheriting the estate |
When is it most useful? | When one spouse's death would create an immediate financial hardship | When the estate will likely need cash after both spouses have died |
Premiums | Generally higher than a comparable survivorship policy covering two lives | May cost less than purchasing two comparable individual permanent life insurance policies because the insurer pays only after the second death |
How Survivorship Life Insurance Policies Can Support Your Estate Plan
Reduce Estate Taxes
To set the record straight, survivorship life insurance doesn't reduce estate taxes simply because you own a policy. In fact, if you or your spouse personally own the policy, the death benefit may be included in your gross estate for federal estate tax purposes.
One common strategy to help avoid that outcome is to have the policy owned by someone else, commonly an Irrevocable Life Insurance Trust (ILIT). By transferring the ownership, the death benefit may be excluded from your taxable estate (provided the ILIT is properly structured).
Of course, someone still needs to pay the policy's premiums. A common approach is for you to make annual gifts to the ILIT, which the trustee then uses to pay those premiums. If the applicable requirements are met, those gifts may qualify for the federal annual gift tax exclusion. At the same time, each completed gift removes those transferred assets from your taxable estate.
Do remember, however, that an ILIT comes with one significant caveat: you generally give up control over the assets transferred into the irrevocable trust. The keyword here is irrevocable. Once the trust has been established and funded, changing or unwinding the arrangement can be difficult.
Preserve Illiquid Assets for Your Heirs
Federal estate tax, when owed, is generally due within nine months after death. Your estate may also face final income taxes, outstanding debts, legal and accounting fees, funeral expenses, property expenses – the full gamut of expenses involved in settling your affairs.
A survivorship policy creates a pool of cash after the second death that can help meet those obligations. That liquidity can reduce the need for a forced sale of investments, real estate, a family business, or other assets simply to raise cash. Thus, your heirs and executor have greater flexibility to carry out your estate plan according to your wishes.
The death benefit is also generally received by the trust or your beneficiaries free of federal income tax. This way, more of the proceeds remain available for those estate settlement costs, debts, or other intended purposes.
Equalize an Inheritance Among Heirs
Leaving cash or even multiple investment accounts to your children is often straightforward, as they can usually be divided into equal shares. The same can't be said for a family business, a farm, or a piece of commercial real estate. Some assets simply aren't practical to split.
A survivorship life insurance policy can help balance those inheritances by providing a separate cash benefit for the heirs who don't receive those indivisible assets.
Here's an example. Suppose you have two sons and own a family business worth $4 million. Son A has spent years working in the company and wants to continue running it. Meanwhile, Son B has built a career elsewhere and has no interest in becoming an owner.
The most sensible solution may be to leave the business to Son A. But what about Son B? Dividing ownership equally simply for the sake of making the inheritance "equal" can create more problems than it solves. It may make decision-making more difficult and put unnecessary strain on both the business and family relationships.
With a survivorship life insurance policy, you can use the insurance proceeds to provide Son B with a separate cash inheritance. That allows you to move forward with your original plan of leaving the business to Son A, provided the business and the insurance proceeds are of roughly comparable value.
Support Business Succession Planning
Passing a family business to the next generation is not as simple as handing over the keys. After both owners die, the business still needs to operate while the estate may simultaneously face a range of expenses and obligations.
Without another source of cash, your heirs may have little choice but to sell company assets, borrow against the business, or even give up part of their ownership interest simply to raise the money needed to settle the estate.
Any of those decisions can place additional financial pressure on the business, undermine its long-term stability, and make it harder for the next generation to keep it running successfully.
A survivorship life insurance policy provides liquidity from outside the business, allowing the estate to meet those obligations without disrupting the company's assets or operations.
Depending on how your succession plan is structured, the proceeds can also help fund buyouts, provide inheritances for family members who won't take over the business, or support a smoother transfer of ownership.
Like any estate planning tool, survivorship life insurance works best as one part of a broader succession plan. Ownership agreements, trusts, buy-sell arrangements, business valuations, and the insurance policy should all work together toward the same goal.
Provide for an Heir With Special Needs
If you have a child or another beneficiary with a disability, your estate plan may need to provide financial support long after you and your spouse are gone – a responsibility that can become one of your most important family or grandparenting goals.
Leaving that beneficiary a large inheritance may seem like the obvious solution. However, doing so can create unintended consequences. For example, if the beneficiary receives means-tested government benefits, such as Supplemental Security Income (SSI), inheriting money outright may affect their eligibility for those programs.
A properly drafted special needs trust can help avoid that problem by holding and managing the money on the beneficiary's behalf rather than placing the assets directly in their name.
Leave Money to Charity
If you and your spouse hope to leave behind a philanthropic legacy, survivorship life insurance can become another tool within your estate plan. You can simply name a qualified charity as the beneficiary of all or part of the policy's death benefit.
Alternatively, you can use the policy to replace wealth given to charity. Certain assets pass to a charitable organization under your estate plan, while the survivorship policy provides a separate inheritance for your children or other beneficiaries.
Borrow Against the Policy's Cash Value to Make Gifts
Estate planning usually focuses on what you'll leave behind after death. However, you may find yourself asking: If I'm passing my wealth to my children or grandchildren anyway, why wait until I'm gone to give them some of it?
If your survivorship life insurance policy accumulates sufficient cash value, you may be able to borrow against it and use the proceeds to make gifts during your lifetime. This can go a long way in helping a child afford a home or fund a grandchild's education.
As long as your gifts stay within the federal annual gift tax exclusion ($19,000 per recipient, per donor, or potentially $38,000 per recipient if both you and your spouse each make qualifying gifts), you can make those gifts without using any of your lifetime federal gift and estate tax exemption.
However, do remember that a policy loan accrues interest, and any outstanding balance reduces the death benefit eventually available to your beneficiaries.
Borrowing too heavily can also put the policy at risk of lapsing. If that happens while a loan remains outstanding, part of the outstanding balance may become taxable. If you're considering this strategy, weigh the benefits of making lifetime gifts against the amount of death benefit your estate may still need later.
When Survivorship Life Insurance Makes Sense
Survivorship life insurance can solve several estate planning problems, but only when it's used for the right purpose and under the right circumstances. That’s to say it isn't always the best solution for every couple.
Before deciding whether survivorship life insurance belongs in your estate plan, consider whether the following statements describe your situation and long-term goals.
Your surviving spouse wouldn't depend on the death benefit for immediate financial support. If your spouse would need insurance proceeds to replace your income, pay the mortgage, or maintain their lifestyle after your death, an individual life insurance policy may be more appropriate.
Your estate could benefit from having additional liquidity after both spouses have passed away. The more your wealth is tied up in illiquid assets, such as a family business, rental properties, or farmland, the stronger the case may be for having a separate source of cash available after the second death.
You have a clear purpose for the death benefit, whether that’s to help pay estate taxes, equalize inheritances, provide for a beneficiary with special needs, or support charitable giving. If you can't identify a clear purpose for the proceeds, paying permanent life insurance premiums for years or decades may be harder to justify.
Your age and health still allow you to obtain suitable coverage. Waiting several years may affect your insurability or the premiums available, particularly if either spouse develops a health condition.
You've considered how the policy would be handled if your circumstances change. Divorce, remarriage, changes in beneficiaries, or major shifts in your family's financial situation may all require updates to your ownership arrangements and estate plan.
See Where Survivorship Life Insurance Fits in Retirement
If you're approaching or already in retirement, survivorship life insurance should be evaluated alongside the rest of your financial plan. Estate planning, Roth conversions, retirement income, tax planning, and wealth transfer strategies all influence whether this type of policy makes sense.
If you'd like help putting those pieces together, Smart Financial Lifestyle can help you build a retirement plan that reflects your family's goals and legacy. Contact us today.
FAQs
Is Survivorship Life Insurance Taxable?
The death benefit from survivorship life insurance is generally not subject to federal income tax. However, the proceeds may be included in the deceased insured's gross estate for federal estate tax purposes if they're payable to the estate or the insured retained certain ownership rights in the policy.
Who Is the Beneficiary of a Survivorship Life Insurance Policy?
The beneficiary is whoever is designated to receive the death benefit after the second insured dies. Depending on your estate plan, that could be your children or other heirs, an irrevocable life insurance trust (ILIT), another trust, or a charity.
What Happens to Survivorship Life Insurance After the First Spouse Dies?
The policy remains in force after the first spouse dies, and no death benefit is paid at that point. Coverage continues on the surviving insured, and the death benefit becomes payable to the beneficiaries after the second insured passes away.
Can a Survivorship Life Insurance Policy Be Put in a Trust?
Yes. A survivorship policy can be owned by an ILIT, which is commonly used in estate planning to keep life insurance proceeds outside the insureds' taxable estates. However, the insureds generally must give up certain ownership rights and control over the policy for the arrangement to accomplish that purpose.
