[Editor’s Note: Gary Dek is a former investment banker and private equity analyst turned personal finance blogger and online marketer. He contributes to MyLifeInsuranceQuotes123.com by providing unbiased life insurance guides for consumers looking for the best coverage. We have no financial conflict of interest.]
Most Americans know their families need life insurance. We’ve all heard of term and whole life insurance because they are the most popular and frequently discussed types of coverage available, but what about other, specific kinds of policies? And which form of life insurance or rider is best suited for high-income earners and self-employed individuals, such as business-owners, physicians, lawyers, dentists, and other professionals?
For example, survivorship life insurance is most commonly used to insure married couples or business partners because it provides coverage for two individuals for a lower cost than two separate life policies. There are two types of survivorship policies: first to die and second to die. Survivorship coverage is available in term life insurance, whole, and modified whole.
First To Die Life Insurance
A first to die life insurance policy pays the death benefit when the first insured policyholder dies. It can be used by business partners to provide funds for the surviving partner to buy out the deceased partner's business interest and cover other expenses that may arise from a partner's death. This can be especially useful since many physician and dental groups form partnerships or LLPs. Meanwhile, married couples may use first to die survivorship life insurance to provide the surviving spouse with money for living expenses that may arise after the first partner dies.
Although this structure is very similar to a traditional term life insurance policy, the difference is that both partners or spouses are covered under one policy. This is cheaper than purchasing 2 individual policies and can be beneficial if one policyholder may be independently uninsurable.
Second To Die Life Insurance
On the other hand, second to die life insurance does not pay the death benefit until the second insured person dies. This type of policy may be used by affluent couples as a hedge against estate taxes for their heirs. The death benefit is separate from the estate and is not subject to estate or income tax. [Editor's Note: The policy cannot be owned by the insured if you want the benefit to be estate tax-free.] An inheriting spouse does not have to pay estate taxes so estate taxes are only due after the death of the second spouse. Family owned businesses also use second to die survivorship life insurance to provide funds to cover taxes and other liquidity needs in the event of death.
As we briefly mentioned before, it is less expensive to insure two individuals under a survivorship policy than to buy two separate life policies. In cases where one spouse or partner may not be able to get life insurance due to a health condition, age or hazardous occupation, it may be possible to get a survivorship life insurance policy.
Survivorship life insurance provides affordable coverage for two individuals and is a useful tool in estate planning for married couples and privately-held businesses anticipating significant estate taxes. However, beware that estate taxes in 2014 do not apply for individuals gifting less than $5,340,000, a $90,000 increase from 2013’s limits, or couples with taxable assets of up to $10.68 million. For all other upper and middle class Americans, the benefits are limited to affordability and insurability.
Since first to die policies are terminated when the death benefit is paid, the surviving partner is left without life insurance and may have to purchase a new policy. Second to die protection is not a good choice if the surviving partner, a physician’s stay-at-home spouse for example, needs funds from a life insurance benefit to pay living or business expenses when the first partner dies.
If you choose a second to die rider on a whole life policy, the surviving partner can use the cash value as collateral for low interest loans, but the unpaid loan balance is deducted from the death benefit, possibly leaving heirs without enough funds to cover taxes. [Editor's Note: While I suppose it is possible to have this issue, I would think that most people who have $10M+ estates aren't going to find that borrowing from their life insurance policies keeps them from meeting their estate tax burden.]
Term vs. Whole Life Insurance
When purchasing a survivorship rider, you will have to determine which type of policy to add it on to – term or whole life insurance. Whole life policies offer cash value, or forced savings account, with a fixed rate of return, but cost 3 to 10 times more than term insurance. Policyholders can use the cash value during their lifetime as security for loans, and the coverage is permanent, making it a [low-returning-ed] long-term investment. For some individuals, whole life makes sense, but for most, it simply is not a good investment.
Meanwhile, term life insurance is temporary and expires at the end of the specified term, usually between 5 and 30 years, so policyholders may have to renew the policy if they need future coverage. Term life, also known as pure insurance, is the cheapest contract available and should be used to protect you when your life insurance needs are greatest. Most applicants choose a 20 to 30 year policy to last until their retirement, when children are out of the house and they have become financially independent.
Overall, given the cost difference between term vs whole life insurance, we recommend you buy term life insurance, save the difference and invest in an index mutual fund. The typical whole life policy has a long term cash value return in the 3-5% range. The stock market has returned a little over 9% per year, on average, for the last 100 years. Compound that difference over the course of 20 to 30 years, and the difference in your net worth is astronomical.
Modified Whole Life Insurance
Just to be thorough, we will discuss another option: modified whole life insurance. Traditional whole life policies have a fixed premium that never increases, but modified whole life offers a lower initial premium that increases at specified intervals. A modified policy may be a good choice for a growing business [that has a need for a permanent policy-ed] since the increasing income of the business should keep pace with the increases in survivorship insurance premiums.
Young married couples may choose a first to die modified whole life insurance policy since their income is also likely to increase. If you are on a budget and think whole life insurance is the kind you want to purchase, consider a modified payment policy. [Most who want insurance “on a budget” should just buy term.-ed]
Comparison Shopping Gets You The Best Rates
One way to decide if survivorship life insurance is the right choice is to compare the rates and policy terms of different types of policies. There are many websites offering free instant life insurance quotes from multiple insurance companies. Couples and business partners can compare different types of coverage, their respective premiums, and the terms and conditions of each company to find the one that best suits their needs and budget. [However, I have yet to see one of these sites that provides instantaneous quotes without personal information for survivorship policies. You're going to need to meet with an agent if you're interested in these specialized policies.-ed]
Survivorship life insurance can be part of a financial plan that ensures the continuation of a family or business even if a partner dies. Survivorship coverage is not the right choice for every couple or business, but it can be an affordable alternative to buying two separate life insurance policies. Research the pros and cons of first and second to die life insurance to determine if they are right for you.
What do you think? Do you or your business own a survivorship policy? How come? Do you see a need for one of these in your life? How come? Comment below!