Should you Buy a Second to Die Policy?

A second to die policy or survivorship life insurance is a life insurance policy that insures two lives and pays a death benefit once both insureds die.  This type of life insurance costs far less than traditional life insurance insuring just one life.  It has a specific life insurance planning application, but some agents look to second to die policies when discussing life insurance for its cash value accumulation.  Today I want to walk through all of the ins and outs of second to die life insurance and help you better understand where it shines and where it most likely doesn't belong.

A Second to Die Policy Example

Second to die policies primarily exist to help families plan for transfer tax payments.  Transfer taxes are those assessed at the death of an individual and represent a tax on the transfer of assets from one person to another (generally non-spousal, but not necessarily always the case).  The most commonly recognized transfer tax in the United States is the Federal Estate Tax.  Several other transfer taxes exist at various state levels, as well as a few other Federal level transfer taxes.

Survivorship policies work to provide the liquidity needed to pay the taxes when due without the need to liquidate other assets to cover the tax bill.

For example, let's say Jack and Dianne have an estate with an estimated Federal Estate tax of $5 million.  While they certainly have assets to cover the tax, the majority of these assets are a business they own and real estate.  If Jack dies, he can easily transfer all of the assets to Dianne as the single owner and no taxes are due at this time (and vice versa).  But when Dianne dies, her estate will need to file IRS Form 706 and pay all estate taxes due within 9 months of Dianne's passing.

Given the complexity of most large estates (i.e. ones large enough to have an estate tax liability), it's highly unlikely Dianne's executor(trix) will be able to sort out and sell the required assets to cover the tax bill within the 9-month timeline.  In some cases, the estate can apply for an extension.  But the other option that will settle the issue faster and keep all of Jack and Dianne's assets intact for their planned heirs, is simply to buy life insurance to pay the taxes due.

The one small problem they face from a strategic timing point of view is knowing who will die first and second.  They could potentially buy regular life insurance insuring each of their lives for half of the calculated estate tax due.  This could work, but the life insurance industry has another option that will generally be less expensive and also potentially avoid the problem if one spouse is healthy while the other is relatively unhealthy.

The answer is the second to die life insurance policy.  It will insure both Jack and Dianne and will pay the death benefit of the policy only once after both insureds have died.

Quick Pro Tip: solving this problem is far more complex than simply buying life insurance.  Federal Tax Laws require Jack and Diane to purchase the policy using specific tools that removes the life insurance from their estate.  If you're interested in this process, here is a video we made as an introduction to irrevocable life insurance trusts and how they work.

Why Survivorship Life Insurance is Cheaper than Traditional Life Insurance

Second to policies offer joint insureds far more death benefit for the same premium than individually insured policies.  Life insurance companies can offer these policies at much cheaper premiums because they represent a far lower cost to the insurer.

There isn't any magic involved here, it's purely mathematical.  The cost life insurers incur to insure someone is the reserve they must hold for the outstanding death benefit.  This is basically the probability that the insured dies in any given year.  Second to die policies can make use of conditional probabilities, which always reduce the probability of an event.  In the case of a survivorship policy, the probability that both insureds die in any given year is significantly less than the probability that one of them dies.

For example, let's assume that the probability that Jack dies is 2% and the probability that Dianne dies is 1.5%.  To calculate the probability that they both die, we simply multiply the two probabilities.  So the probability that they both die this year is 0.03%.

This significant difference in probability that the life insurer will need to pay a death claim allows the insurer to charge far less for a survivorship policy than it would on an individually insured life insurance policy.

To compare the pricing of a second to die policy to a regular life insurance policy insuring just one life, I pulled an example of whole life policies.

Assuming a male and female both age 45 seeking a $1 million death benefit, the required whole life premiums break down as follows.

The required premium for the 45-year-old male is $16,730 per year.

The required premium for the 45-year-old female is $14,820 per year.

The required premium for the second to die policy is $11,129 per year.

Even if this hypothetical couple wanted to split up the death benefit and buy $500,000 on each, the breakdown in premiums is as follows.

The required premium for the 45-year-old male is $8,430 per year.

The required premium for the 45-year-old female is $7,560 per year.

Combining the two premiums when splitting the death benefit up, this couple pays $15,990 per year to have a combined $1 million covering them both, that's $4,861 more than the survivorship life insurance policy.

The second to die policy is perfectly designed to address the transfer tax issue.  Couples generally buy life insurance only for the tax liability.  The tax liability is usually due at the passing of the last surviving spouse (Quick Note: there was a time when this was less often the case, but due to changes in tax laws, it's now the case the vast majority of the time).   Couples can guess, but they rarely know which spouse will die first.  Survivorship life insurance handles all of this and does it at a significant discount versus traditional life insurance with a single insured life.

Should you use this Type of Policy for Cash Accumulation Plans?

It's tempting to think that second to die policies will take the strategy of using life insurance as a retirement plan or other long term saving strategy and boost the results.  While it's certainly the case that a survivorship policy has all the usual tax benefits life insurance enjoys, the lower cost of these policies doesn't always mean they will perform better in terms of rate of return on premiums paid.

For example, here's a comparison of a scenario using either individually insured whole life insurance versus a second to die whole life policy issued by the same company:

We'll assume husband and wife both age 45 looking to put $25,000 each into a whole life policy for retirement income planning (that means the policies use a design to maximize the cash value and potential income from the whole life insurance).  Alternatively, they could buy one second to die policy with a $50,000 annual premium (also using the same design tweaks to optimize cash value and income).

Male age 45:

Male age 45 Life Insurance Retirement Plan 25kFemale age 45:

Female age 45 Life Insurance Retirement Plan 25k

Second to Die Policy male and female age 45:

Second to Die Policy ExampleSome key observations from these results:

The second to die policy has much larger death benefit than the combined death benefits from the individually insured policies.  For all three policies, this is the minimum non-Modified Endowment Contract (MEC) death benefit for the planned premium.  This means that is the lowest death benefit we can have to not violate the Seven Pay Test and cause the policy to be a MEC if we pay this premium amount into the policy.

The individually underwritten policies have considerably more cash value combined between them in the first year versus the second to die policy.  The individual policies maintain a higher cash position indefinitely.

The second to die policy, however, projects slightly more maximum income than the individual policies (I solved maximum income from age 66 to age 100) despite the second to die policy having less money than the combined individual policies in the year income begins.  This is a result that requires us to be slightly suspicious.  I theorize that lower long term costs in the second to die policy drive this higher income projection–I'd still be cautious to believe it and make a recommendation that someone buy the survivorship policy over the individual policies).

There are also several practical impediments to recommending a second to die policy in this context.

First, while many people who come to us looking to buy life insurance purely for its cash accumulation features tell us that the death benefit is unimportant to them, we find that 95% of the time the death benefit becomes slightly more important along the way of selecting the right policy for them.  Because a second to die policy pays no death benefit until both individuals die, this takes the death benefit off the table in a way few people desire.  This is largely the case because using life insurance in this fashion may hold death benefit as a secondary priority, but it rarely removes it entirely from the picture.  In other words, having the death benefit provides an added layer of financial security that many people greatly appreciate.  Survivorship policies simply cannot do this.

Second, when there is an income disparity between husband and wife (often the case in our experience) the second to die policy creates a large potential burden on the lower-income earning spouse should he/she survivor the higher income earning spouse.  This is not the case for situations where each spouse has a policy insuring him/her.  Should one spouse die, the death benefit creates the needed capital to continue life as planned.

Third, but somewhat tied to the second point, when using life insurance for income (such as the example from above) the death benefit of a policy can provide an even greater degree to peace of mind when one spouse passes.  The death benefit can add an additional layer of security for the remaining spouse in the pursuit of not outliving the money the couple saved for retirement.

Great for Estate Planning, Not so Great for Cash Focused Plans

Second to die policies are a great tool for estate planning.  This could be a plan to provide funds for transfer taxes, or simply to augment money earmarked for heirs or charitable purposes.  There's also a possible application for these products to help with some degree of long term care expense planning.

But as a cash accumulation vehicle, survivorship life insurance doesn't often shine bright against an alternative individually insured plan.  The individual plans tend to work out better for accumulating cash value and they provide additional financial security a second to die policy cannot.

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