Second to Die (Survivorship)

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1 WD & Associates WILLIAM DELMAGE President 22 Hemingway Drive East Providence, RI (401) Second to Die (Survivorship)

2 WD & Associates Page 2 Second to Die (Survivorship) What is a second-to-die (survivorship) policy? A second-to-die or survivorship policy is a life insurance policy that covers two lives under one contract. The death benefit is paid when the second person dies. Nothing is paid at the first death, and premiums continue to be paid until the second death. When can it be used? Personal Use Create an estate Survivorship life insurance can be used to create a substantial estate. A married couple with a modest estate can use a survivorship policy to increase the inheritance intended for their beneficiaries. This type of policy features less expensive premiums than two individual policies, allowing the couple to buy a survivorship policy with a larger death benefit than might otherwise be affordable using separate policies. Preserve an estate Survivorship life insurance can be used to preserve an existing estate by providing cash for estate settlement costs and taxes. Careful structuring of the policy size, ownership, and beneficiary designation can allow the bulk of the estate to remain intact, while the survivorship life insurance proceeds are used to cover taxes and expenses. Protect two-income family A survivorship policy can be used to protect a two-income family when the loss of one income may be tolerable but the loss of both incomes would leave dependents without financial support. The use of the word "family" doesn't have to be strictly applied--it can also be used by unmarried people who share joint financial or dependent care obligations. Provide for dependent with special needs Sometimes a couple will have a dependent with special physical or mental needs, such as a child or an aged parent. Survivorship life insurance can be used to create an estate for the benefit of such a dependent. The proceeds from the policy would provide a sum of money available for the continued care and support of the dependent. Be very careful when drafting the beneficiary designation on a policy to be used to provide for a dependent with special needs. Make sure that the receipt of the survivorship policy proceeds doesn't result in the disqualification for government aid for the dependent. Business Use Buy-sell agreement A survivorship policy can be used in a specialized buy-sell agreement where the business interest buyout occurs after the death of the second owner. This, however, is not the most common type of buy-sell agreement arrangement.

3 WD & Associates Page 3 Key person protection A survivorship policy can be used to cover multiple key people in the business. It is useful when it is expected that the loss of one key person could be overcome but the loss of two key employees could not be. Strengths Useful for funding estate taxes when full marital deduction used Survivorship life insurance policies are often used for funding the estate taxes of wealthy couples whose estate plans make maximum use of estate tax deferral at the first death. Due to the structure of the tax system and the marital deduction, there is a likelihood of greater taxes due at the death of the surviving spouse than when the first spouse dies. In general, at the death of a spouse, all property in the deceased's estate that passes to the surviving spouse in a qualified manner is not subject to estate tax, because of the unlimited marital deduction. When the surviving spouse dies, the property that passed from the first spouse to the second spouse, in addition to the property otherwise held by the second spouse will be taxed at the death of the second spouse. A survivorship policy can be used to provide cash for the taxes due at this time. Policy may be issued even when one person in poor health or uninsurable Insurance companies often issue survivorship policies even when one of the parties is in poor health or is considered uninsurable for an individual policy. This is because only one death benefit is paid and not until the last person covered dies. Even though one party may be deemed uninsurable for a single policy, there is little or no additional risk for the insurance company with a survivorship policy. Rated or uninsurable parties can often buy survivorship coverage at standard rates. Premiums are often based on the average age of the joint insureds and are usually lower than on a policy on either life alone because the insurance company has the premiums longer before paying out a benefit. Premiums more cost effective than multiple individual policies The premiums for a survivorship life insurance policy are lower than the premiums would be for two individual policies because the insurance company pays only one death benefit. As a result, the joint insureds may be able to purchase a policy with a larger death benefit than might be possible with individual policies. Coverage offered in variety of forms Survivorship policies are offered in many forms, including whole life, variable universal life, current assumption whole life, or universal life. These forms all contain cash values that may be accessed during the lifetime of the insureds through policy loans. Caution: Variable life insurance and variable universal life insurance policies are offered by prospectus, which you can obtain from your financial professional or the insurance company. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. You should read the prospectus and consider this information carefully before purchasing a variable life or variable universal life insurance policy. Tradeoffs No benefit paid at first death By design, the survivorship policy doesn't pay a death benefit at the first death. It is possible that the survivor could be left without sufficient financial resources for settlement of the estate or to allow continuation of the premium payments. If the unlimited marital deduction doesn't apply to the full estate (a situation common when there are children from a previous marriage), estate taxes may be due at the first death, and there may not be cash available to pay such taxes.

4 WD & Associates Page 4 Some survivorship life insurance policies can include a term rider covering the first to die that would provide a benefit to provide income for the survivor or cash for estate expenses. Check the provisions of the rider because many expire before either insured reaches life expectancy. Survivor may be required to keep paying premiums The survivor under the survivorship policy may be required to continue paying premiums in order to keep the policy in force. This could represent a significant financial burden to the survivor. Depending on the policy terms, it is possible that the premiums could even increase after the first death due to an increase in the mortality charge. Some policies consider the policy paid up at the first death due to a mushrooming in the cash value account. Other policies allow the purchase of a rider allowing the policy to be paid up at the first death. Check for these features on any survivorship policies you are considering. How to do it Determine your life insurance need and overall financial goals Before you buy life insurance, you need to know how much insurance you need. Insurance need is based on numerous factors, including your current age and income, marital status, number of incomes in the household, number of dependents, long-term financial goals, level of outstanding debt, and existing insurance and other assets. Your overall financial, estate, and tax-planning goals and your planning horizon should be considered as part of your insurance-need evaluation. For more information on determining appropriate levels of life insurance, see How Much Is Enough? Tip: Consult with your financial advisor concerning your need for insurance. Some of the calculations can be complicated. Complete the insurance application and name your beneficiary Before the insurance company can issue your policy, it must receive a completed application form. The application includes general health questions, and the process may include a physical examination, which is usually paid for by the insurance company. A critical part of the application is the beneficiary designation--the naming of the person or persons to receive the policy proceeds when you die. Unless you make an irrevocable beneficiary designation, you can change the beneficiary designation by adding or removing a beneficiary or by changing the percentages of the proceeds distribution. Buy the policy and pay your premium It is all well and good to know how much insurance and what type of policy is appropriate for your particular situation. But if you don't actually buy the policy, you haven't accomplished your goal! Not only that, but insurance becomes more expensive with age, so you won't be doing your wallet any favors by delaying. Review your insurance need periodically The amount of life insurance you need may change over time and with the occurrence of lifetime events. As a result, you should periodically review your life insurance coverage. As a rule, you should review your coverage every three years. Major lifetime events (such as the purchase of a home, birth or adoption of a child, marriage, or divorce) are also appropriate times to review your coverage. By routinely checking your insurance need, you can prevent the mistake you can't fix after you die: not having enough life insurance. Tax considerations

5 WD & Associates Page 5 Income Tax Premium payments not deductible Life insurance premium payments are generally not tax-deductible expenses. Cash withdrawals may not be taxable Life insurance policy cash value withdrawals (assuming the policy is not classified as a modified endowment contract, or MEC) are considered a nontaxable recovery of your policy cost basis until the entire policy basis has been withdrawn. Example(s): You own a life insurance policy with a cash value of $15,000. Your basis in the policy equals $12,500. You plan to take a withdrawal of $7,000 now to pay for part of your son's tuition. You won't have to pay tax on this withdrawal amount because it will be considered a return of your cost basis. Balances before Withdrawal Withdrawal Amount Cash Value $15,000 -$7,000 $8,000 Balances after Withdrawal Your Basis $12,500 -$7,000 $5,500 0 Withdrawal Subject to Tax Caution: Withdrawals in excess of your basis are treated as taxable distributions of interest or gain. Caution: Cash value withdrawals that occur in the first 15 years of the policy and are accompanied by a reduction in the death benefit may be treated as first coming from interest. Policy loan proceeds generally not taxable When you take out a loan against your life insurance policy (except a policy classified as an MEC), the amount you receive is not considered taxable income. This rule applies even when the loan is larger than the amount of premiums you have paid in. Example(s): You own a life insurance policy (not classified as an MEC) with a cash value of $20,000. Your basis in the policy is $14,000. You decide to take a policy loan to pay your daughter's college tuition. Under the terms of your policy, you are allowed to take a loan for an amount up to 90 percent of the policy cash value--in this case, $18,000 ($20,000 x.90). You are not currently subject to tax on the amount of the loan, even though the loan is larger than your basis. Caution: If you cancel your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus any accrued but unpaid interest). Policy loan interest not deductible Interest you pay on a policy loan is not a tax-deductible expense when the loan is for purposes other than business or investments. Policy cancellation may be taxable Caution: You may be subject to surrender charges. Check your policy.

6 WD & Associates Page 6 Caution: Policy fees and expenses are usually charged against the policy in the first few years. As a result, policy surrenders during the first few years of the policy may provide little cash value. Caution: If you surrender your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus any accrued but unpaid interest). Policy lapse may be taxable If you allow your policy to lapse, you could be subject to income tax even if you don't receive any cash from the policy. A policy lapse can occur when you stop paying premiums and don't have cash values available that can be used to pay the premiums. If you have an outstanding policy loan, it is possible you could be subject to tax on the amount of the loan plus any accrued but unpaid interest. Death benefits generally not subject to federal income tax Policy death benefits are generally not subject to federal income tax. One notable exception is when the policy has been sold or otherwise transferred for valuable consideration by one policyowner to another, subjecting it to the transfer-for-value rule. Gift Tax Policy proceeds not considered gift to beneficiary When the proceeds of your life insurance policy are paid to a beneficiary, they are not treated as a gift for gift tax purposes. Policy premium payments generally not subject to gift tax When you are the owner of a policy on your own life, with another party as the beneficiary, premium payments made by you are not considered a gift to the beneficiary for gift tax purposes. If, however, someone else pays the premiums on a policy you own, the premium payments are considered a gift to you and may be subject to gift tax. However, policy premiums generally qualify for the annual gift tax exclusion. Estate Tax Policy value included in estate value in some cases The proceeds of a life insurance policy are included in the value of your estate if you held any incidents of ownership at any time during the three years before your death or if the proceeds are payable to you or your estate. Incidents of ownership include (among other things) the right to change the beneficiary, take out policy loans, or surrender the policy for cash. With a survivorship policy, both parties may hold incidents of ownership, and it is possible that the Internal Revenue Service may try to include the value of the policy in the estate of the first to die even though no death benefit is paid until the second death. Policy proceeds often exempt from state inheritance tax In many states, life insurance proceeds are exempt from state inheritance taxes. Questions & Answers If you are covered under a group life insurance policy through your employer, do you still need a personal policy? Yes, you should have your own policy outside the group coverage provided by your employer. The policy through your current employer is more than likely not portable--meaning that when you leave the company, your life insurance coverage will not go with you. It is very common for people to change jobs numerous times during their career. Even if you plan to stay with your current job until retirement (assuming your job exists that long), what will you have for coverage afterward? The best way to make sure your family is provided for when you die is

7 WD & Associates Page 7 to have your own insurance coverage in addition to any provided by your employer. While conversion coverage may be available, it may be expensive and it may offer limited coverage. In addition, it may not meet all of your coverage needs. Can your spouse own a policy on your life and name your child as beneficiary? This can be done, but it shouldn't be. When the insured, the policyowner, and the beneficiary are three different parties (sometimes referred to as the "unholy trinity" or the "Bermuda triangle"), the death benefit may be subject to gift tax. Can you name your spouse as the beneficiary on your life insurance policy if he or she is not a U.S. citizen? You can, but there could be estate tax consequences. When your spouse isn't a U.S. citizen and is the beneficiary on your life insurance policy, the death benefit isn't protected by the unlimited marital deduction. Should you buy life insurance on your children? In some instances it is advisable to buy life insurance on your children, but it shouldn't be done until the appropriate levels of coverage are in place on the lives of the family breadwinner(s) and a non-wage-earning spouse engaged in the care of the children. Should you buy term insurance or cash value life insurance? It depends upon your personal circumstances. The first issue to resolve is not what type, but how much life insurance you should buy, and how long your coverage is needed. Once you can answer the quantifiable insurance question, you can move on to the financial aspect. It is possible that the amount of coverage you need is so large that the only affordable way to get the coverage is with lower-premium term insurance. If you can afford the needed coverage with either type of policy, then you should think about the financial aspect of which type of policy to buy, considering such factors as your tax bracket and the rate of return you could receive on alternative, similar risk investments. With cash value life insurance, does your beneficiary get the death benefit plus the cash value amount? Maybe. Check the policy. Many cash value policies are written in such a way that the beneficiary receives only the face amount of the policy at death. The cash value is applied to partially pay off the death benefit. There are policies that will pay the beneficiary the face amount plus the cash value, but the premiums tend to be higher. Don't just assume that your policy will pay both amounts--check the policy and/or ask your agent. Should you "invest" in insurance? It generally isn't a good idea to buy insurance unless you need it. If you want to invest money, many options are available. When you need insurance, there are policy types available that can serve the dual purpose of insurance protection and cash value investments. The bottom line is, don't buy insurance because you are looking for an investment--buy insurance because you need the protection.

8 Page 8 WD & Associates WILLIAM DELMAGE President 22 Hemingway Drive East Providence, RI (401) wmd@wdandassociates.com Forefield Inc. does not provide legal, tax, or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or for the accuracy of information provided by other sources. Prepared by Forefield Inc. Copyright 2010 Forefield Inc.