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Under current law, any estates are subject to a substantial estate tax of up to 40 percent on assets in excess of $5.45 million.

That's where survivorship life insurance - also called "second-to-die" life insurance - comes in. A second-to-die life insurance policy pays out an immediate cash benefit, tax-free, upon the death of the second spouse - not the first one.

One common purpose for second-to-die life insurance is to provide a large amount of liquidity to pay estate taxes.

This can be important when a family's wealth is tied up in illiquid assets that are difficult to sell. With a second-to-die life insurance policy in place, the family or estate executors receive the tax-free cash death benefit right away, and can use that to pay estate taxes, rather than be forced to sell off assets like small businesses and real estate to raise the cash. Otherwise, heirs may be forced to sell assets in the estate at heavily discounted prices, or at a very poor time in the market to sell, to meet the estate tax deadline.

Second-to-die policies also typically have lower premiums for a given death benefit than standard single-insured life insurance policies.

Use of Trusts to Move Life Insurance Out of the Taxable Estate

Who owns the insurance policy itself? It may be prudent to set up an irrevocable trust, and have the trust own the life insurance policy, rather than own it directly, in your own name. Otherwise, the life insurance policy would be considered part of the taxable estate, and increase your tax bill. Setting up a properly constructed irrevocable trust will help you avoid this problem.

To set up the trust, speak with a qualified attorney and your tax advisor. Only a licensed attorney can actually write the documents required to set up the trust and ensure that the trust meets the requirements necessary for the assets in the trust to be considered separate from the taxable estate of the deceased. Once the trust is established, the trust can then become the owner of the life insurance policy.

But the applications of the second-to-die life insurance policy don't stop there. Even if you don't expect your estate to be big enough to be subject to federal estate tax, there are a number of other uses for the second-to-die life insurance.

• Funding for buy-sell agreements where married couples operate their interests in a company together.
• To provide for equal distribution of an illiquid estate to children. For example, one child may be able to run an inherited family business or farm, while other children may not have the interest or aptitude. Life insurance allows one child to receive the business and the others to receive cash, rather than forcing them all to liquidate a viable family-owned business.
• Funding for special needs children, who will still need support even after the death of the second parent. The parents can set up a special needs trust to support the child - now an adult in many cases. This provides for support for the child without compromising his or her ability to qualify for Medicaid, food stamps or other need-based assistance.
• To provide funding for the education of grandchildren.

There are other specialized applications where second-to-die life insurance works extremely well as a planning tool. For more information, ask your life insurance advisor.

Contact our life insurance team Insurance Loft today to learn more about protecting your estate.