When you’ve worked hard and accumulated wealth, you want as much as possible to go to the people and places that are important to you. Survivorship, or second-to-die, insurance is a tool families can use as part of their estate plan to ensure cash is available to cover expenses or provide for beneficiaries.

For married couples who want to reduce their taxable estate during their lifetimes and pass on a larger legacy upon the survivor’s death, survivorship insurance can help them achieve estate-planning goals. 

Chicago estate planning law firm Plan Forward Legal is committed to helping families prepare for the future and ensuring they have the tools to minimize taxes and maximize wealth transfer. 

Life Insurance as an Estate Planning Tool

For estate tax purposes, your estate consists of the value of all real and personal property you own at the time of your death. Property can be included in your estate even if it passes directly to a beneficiary and bypasses the probate process. 

If the value of your estate exceeds the allowable exemption, the estate will be liable to pay any tax due. Without proper planning, property in an estate may have to be liquidated to pay estate tax, which can lead to unintended consequences for estate distributions.  

The value of a life insurance policy will be included in the estate of the policy’s owner. Though the policy proceeds go directly to the named beneficiary and are not taxed as income, they are still included in a decedent’s taxable estate as long as the decedent is considered the owner of the policy.

An Irrevocable Life Insurance Trust can Remove Life Insurance from Your Estate

Creating an irrevocable life insurance trust (ILIT) that will own the life insurance policy can remove the value of the policy from your estate, thereby reducing the taxable estate and increasing the amounts available for recipients.

For an ILIT to effectively remove the value of a life insurance policy from a taxable estate, the IRS requires the following to be true:

• The insured retains no ‘incidents of ownership’ in the policy 
• The beneficiary is not the insured’s estate
• A beneficiary is alive at the insured’s death
• The policy is not transferred to the trust within 3 years of the insured’s death

To avoid maintaining any incidents of ownership, the insured must relinquish all rights, benefits, and control over the policy. When the policy is purchased by the trust rather than by the insured and subsequently transferred, the three-year look-back rule does not apply. 

The Differences between Survivorship Insurance and Other Life Insurance

ILITs can work with any life insurance policy for owners who don’t want the policy value included in their estates. Survivorship insurance is generally used by married couples facing estate taxes. Unlike separate life insurance policies that pay upon the death of one insured, survivorship policies do not pay out until the second spouse dies. 

Survivorship policies also offer the following advantages, making them highly workable for estate planning.

Lower Premiums

It will cost less to purchase the same amount of coverage with a survivorship policy than two separate policies. This is because the insurance company can spread the payout risk over a longer period. 

Easier to Qualify

Because the insurance company can spread the risk over a longer period, it may accept one partner’s health issues if the other partner is healthy, allowing both to qualify for coverage. 

How to Use Survivorship Insurance as an Estate Planning Strategy

Survivorship insurance is used with an irrevocable trust for people who want to reduce the estate tax they will have to pay and have specific plans for where they want the money to be available. 

Here’s how it works.

A married couple will have an estate planning attorney draft an irrevocable trust. The couple will select an independent trustee to manage the trust. The trustee will purchase the survivorship insurance with funds gifted to the trust by the couple. 

The insured couple must give up their rights to any beneficial interest in the policy, including the right to change beneficiaries. Any attempt to retain control over the policy will likely render the trust ineffective for estate tax purposes. 

Annual insurance premiums can often be paid with tax-free contributions to the trust that coincide with the annual gift tax exclusion. Specific language must be used in the trust document to ensure annual contributions qualify for the gift tax exclusion. Gifting the annual premiums to the trust further reduces a taxable estate.

The Downside to Using Survivorship Insurance in Estate Planning

Using survivorship insurance in estate planning presumes that a couple will stay married until one of them dies. Before creating an ILIT, a couple should consider what they want to happen if they divorce.

Once the trust is created, its terms cannot be changed, but the document can direct the trustee on how to handle the insurance policy in the event of a divorce. Trying to back out of an insurance policy owned by an irrevocable trust can get messy and possibly expensive if a plan is not in place to anticipate the worst-case scenario. 

Survivorship insurance also does not provide any income to the survivor during their lifetime, so it is not appropriate for couples who want to provide a benefit to the surviving spouse.

Work with an Estate Planning Attorney who Plans for Contingencies

Estate planning is a bit like trying to hit a moving target. We don’t really know what will happen in the future, so we make our best guess and plan accordingly. We want to be responsible, though, so a little bit of leaving our options open can give us more flexibility should unanticipated circumstances develop. 

At Plan Forward Legal, we carefully counsel estate planning clients so they understand the benefits and risks of using particular planning tools. We help clients map potential scenarios and plan for unlikely outcomes so they are prepared for whatever may happen. Are you ready for tomorrow? Call an estate planning attorney at Plan Forward Legal.