Second-to-die life insurance, or survivorship insurance, was mainly intended for one purpose: Pay any estate taxes for nonspouse heirs over the estate tax exemption.

This year the exemption rose 75%, to $7 million per couple or $3.5 million per spouse. It’s impossible to say what will happen to estate taxes, but that exemption is likely to remain where it is for several years.

Estate tax liability can be devastating, especially when a family business is involved. Without proper planning, heirs may have to liquidate the business to pay taxes. Second-to-die policies can protect the legacy of married clients who have — or are likely to amass — significant assets, and can help supplement retirement income tax-free, as long as the policy stays in place until death.

“Wealthy couples face significant estate tax liability: 45% federal and another 5% in some states,” says Jeff Cullen, manager of estate and business planning at Hartford Financial Services Group Inc. in Simsbury, Conn. “So for a couple with an estate that is $10 million more than the exemption, when the second spouse dies, $5 million in taxes would be due nine months after the date of death.”

Any decision about survivorship insurance starts with the client’s needs, he said; if the client wants to pass money on to heirs, what is the estate tax exposure today, and what is it likely to be in the future? The future liability determines the need for a policy.

“A couple, both age 60, with $10 million in assets could double their money every 10 years, and given current mortality rates, that could mean an estate of $50 million when the second spouse dies,” Cullen said. “At the current estate tax rate of 45%, the couple will need a death benefit of $22.5 million to cover the tax bill in order to pass on that full amount to their heirs.”

Advisers should check whether second-to-die premiums would be cheaper than those on an individual universal life policy. Second-to-die policies are like universal and variable universal policies, except they cover two people and therefore tend to have lower premiums.

For a life insurer, the worst-case scenario is that a healthy person dies shortly after buying a policy; in that case, the individual has made minimal payments before the insurer must pay a whopping death benefit. The likelihood of a quick payout is slim, but it falls dramatically if the policy covers two people, because the chances of them both dying early are lower.

For high-net-worth clients in their 20s and 30s, where one spouse is the principal breadwinner, a single-life policy often makes more sense, according to experts, since the premiums are so low for young people. Second-to-die policies are usually for people in their 50s to 80s; the younger the client is when the policy is bought, the cheaper the premiums are.

Consumers can pay for second-to-die insurance with higher fixed premiums or premiums that start out low and rise as the owner ages. A $10 million policy might cost a 30-year-old in good health 0.5% in annual premiums, Cullen said. At age 70, the cost would rise to 3% or 4%, depending on the client’s health.

“Policyholders can choose to overpay when they are younger and premiums are lower. The excess goes into a cash balance account, which grows over time and can cover payment of premiums in the future,” he said. “That was the original intent of cash balances within life insurance policies.”

Like universal life insurance, policies house a “cash balance” component, which was originally intended to pay the premiums in the future, but now can be used for other purposes, Cullen said. Also, like universal life insurance, the cash balance can be invested in a fixed-income vehicle or in mutual funds.

Second-to-die policies are commonly used in conjunction with irrevocable trusts, because otherwise the death benefit would stay in the couple’s estate when the second spouse dies. Advisers usually get clients’ attorneys to create a trust, which owns the policy outside the estate and pays the premiums.

“A couple can gift up to $12,000 per year each to pay the premiums. The larger the benefit and the older the policyholders, the higher the premium rate, but $24,000 is usually enough in most cases,” said Gordon Homes, a senior financial planner at MetLife Inc.

Many planners recommend dynasty trusts, which hold assets for a wealthy couple’s children and grandchildren and can last for a lifetime plus 21 years.

“If your two-year-old granddaughter lives to 85, the trust can hold the assets for 21 years after her death,” Cullen said. “Some states have repealed this, so the race is to establish the trust in more liberal states.” In South Dakota and Florida, both at the liberal extreme of state law, these trusts can last for 300 years.

Once the money is in an irrevocable trust, the policyholder cannot touch the cash balance but can use the policy to provide limited funds to the other spouse, even while the owner is alive, through a spousal access trust.

How cash balances are used has evolved since their inception, and now policyholders who do not wish to use the policy for tax purposes can use the cash balance as an extension of qualified retirement plans while avoiding restrictions like contribution limits and withdrawal penalties and minimums.

If there is enough money built up in the cash balance, policyholders can withdraw money tax-free as a preferential loan. “The Internal Revenue Service has a long-standing rule that these loans are early payment of death benefits,” said Scott Fryklund, senior vice president and national sales manager of life and long-term-care in Minneapolis for Allianz Group.

Advisers must ensure that clients do not take out too much — or they may accidentally spend money that would have covered the premium, he said. If that happens, the policy lapses, and “anything you’d taken out would be taxable at that time, so you have to be very careful not to do that.”

Survivorship insurance is one of the few products offering protection to the client’s family in the event of early death and a tax-advantaged account the client can access tax-free in retirement.

For advisers leery of insurance products, the good news is that second-to-die policies are a relatively easy sell, according to experts. First, the risk that a wealthy couple will be turned down is minimal if one spouse is in reasonable health. Second, it is a fairly natural conversation if the adviser focuses on the need and not the product.

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