How to Use a Second to Die Life Insurance Policy

Aug 24, 2021

How to Use a Second to Die Life Insurance Policy

Second-To-Die Life Insurance Bought to Cover Estate TaxesThis is insurance that identifies two insureds (usually spouses) and pays off on the death of the second one.  This is heavily promoted to doctors as "cheap" insurance and the "ideal" way to provide money to the kids to pay estate taxes that become due after the second parent passes away.  Our reactions:

These Policies Are NOT Cheap: The premium looks lower than what a doctor is used to seeing because the insurance company presumes a later pay-out date due to the need for both parties to die.  Never be so naive as to believe the insurance companies are giving something away for free.

Life Insurance Is A Crummy "Investment":  We are not at all impressed with the idea that a doctor with sufficient liquid assets (cash, securities, etc.) to cover estate taxes should buy life insurance for that purpose. First, if either spouse lives to a normal life expectancy and the money that would have been spent on the insurance is invested rationally, the children should come out ahead -- although they probably won't realize it as insurance proceeds look like a free windfall to the recipient.  Second, if you need to spend the money that would have been spent on the insurance to maintain your standard of living, the kids came out behind but you came out ahead (our preferred priority).

Do You Want To Be Buying More Insurance Every Few Years?  If you accept the notion you should "protect" the kids by covering death taxes with life insurance, you're trapped.  You provide an annuity to the insurance company by (1) having to keep the insurance for your entire life and (2) having to perpetually buy new policies as your net worth increases.

When We WOULD Consider This Insurance:  We would definitely consider buying some second-to-die insurance in the case where the children would be left with illiquid assets (art, land, etc.) and might have trouble raising the estate tax money in a down market.  We would also consider these policies where both spouses are high income earners but have little in savings.  If either spouse died, the survivor's income would be adequate for the family, but if both died, there would not be enough, without insurance, to take care of the kids.

We Are Not Anti-Life InsuranceLife insurance, like all insurance, should be bought when there is a risk we cannot afford to carry ourselves. (For example: we would question why a sixty year old, healthy, wealthy doctor who can easily afford to retire would continue to pay disability insurance premiums.)

The risk as we see it for life insurance is not that we will die someday.  It's that we could die, leaving behind a family with insufficient assets to support themselves.  Term life insurance is cheap and plentiful and fills that gap beautifully.  In the typical doctor's career, a point comes when the gap is eliminated, i.e., savings will be more than enough to support the family if the doctor dies -- the kids have been educated, debts are small, savings high, etc.  At that point, the risk is gone and the insurance can be cut or eliminated.

No, we are not impressed by the argument from insurance salesmen that everyone needs life insurance to pay death taxes.  If mom or dad live to a normal life expectancy and the estate is not tied up in unsalable real estate, art, etc., the kids will usually be wealthier if mom and dad had invested their money instead of buying life insurance and had good estate/gift planning advice along the way. Think about it.

Irrevocable Life Insurance TrustsThis is not a sales gimmick.  If you have a lot of life insurance, it is probably wise to have it owned by an irrevocable life insurance trust.  Life insurance benefits count in your estate for estate tax purposes unless you retain no incidents of ownership over the policy.  If structured properly, it can be excluded from your taxable estate by having it owned in an irrevocable trust.  You would then make gifts to the trust each year so the trustee can pay the premiums.  Technically, you maintain no control over the policy.  Upon your death, the proceeds would be paid to the trust and used to support your family. Upon your spouse's subsequent death, the remaining proceeds would not be counted in your spouse's estate because he or she, too, had no control over the trust assets.  Usually, your spouse acts as the trustee.  He/she is the beneficiary during his/her life and eligible to take distributions to support his/her lifestyle.  But, if an estate tax is possibly in the family’s future, then this should be the last account to be drawing money from.

The goal is for your children to eventually inherit the remaining proceeds from this trust undiminished by estate and gift taxes.  If the spouse draws money out of this trust during his/her life, then it comes into his/her estate.  This should only happen once all other accounts have been depleted.

Interested in learning other investment strategies and techniques? Join us at one of our upcoming advanced investment seminars.


Collier & Associates, Inc. provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Readers should not act on this information without seeking advice from professional advisors.

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