Second-to-die life insurance originally was designed to provide liquidity for federal estate taxes and other estate needs.
However, the life insurance industry is unrivaled for its creativity in applying its product offerings. As a result, a number of uses for second-to-die policies have been developed since the product’s inception. Here are some situations in which second-to-die insurance is a solution for a client need.
A husband and a wife own a business, and both intend to stay active in that business until they die. The sale of the business to a new owner should take place after both members of the couple die. In such a situation, the husband and the wife would enter into a buy/sell agreement with the prospective purchaser, and the agreement would say that the sale would take place upon the second death of either the husband or the wife.
To fund the purchase, the prospective buyer would acquire a second-to-die policy on the husband and wife. Then, upon the second death in the couple, the purchaser would collect the death proceeds and consummate the sale.
The greatest risk to a special-needs child comes upon the death of the second parent, when neither is left to look after their child. To alleviate this risk, the parents could create a special-needs trust funded with a second-to-die policy on their lives. The next step is to make the child a discretionary beneficiary of the trust, which means that the child can receive only what the trustee chooses to give the child. Consequently, the child cannot demand any benefits from the trust.
This prevents the assets of the trust from being considered the child’s assets, the existence of which would disqualify the child from receiving needs-based government benefits such as Medicaid. The bottom line is that the child could qualify to receive basic support from government needs-based programs, while the trust provides the child with the extras that make for a better quality of life.
Married couples frequently use the by-pass trust/marital deduction approach in drafting their wills. This approach will postpone all federal estate taxes until the second death. Consequently, they need a life insurance contract that pays the death benefit upon the second death, when the tax becomes due. A second-to-die contract is perfect for this purpose. It usually is purchased through an irrevocable life insurance trust to avoid estate tax on the death proceeds.
For the first time in American history, the “American dream” is gone from the younger generations’ minds — they are unsure if they will do as well as their parents. This means that parents must be concerned about more than simply educating their children.
Parents also should start thinking about establishing dynasty trusts to help ensure their children and subsequent generations have a better chance at a good life. That can be accomplished by having the parents establish an irrevocable life insurance trust funded with a second-to-die policy on the parents.
In such a situation, after both parents are dead, the trustee would collect the death proceeds and use the funds as a form of family bank to benefit generation after generation of their family. For example, the trust could loan money to the insureds’ descendants to purchase homes or start businesses. Further, the trust could provide funds for educational or medical expenses or any other family needs.
Due to the tremendous cost of a college education, some grandparents may be concerned about their children’s financial ability to provide such an education to the next generation. Certainly, while the grandparents are alive, they can assist in paying for their grandchildren’s higher education. But what happens after the grandparents are gone?
To make sure that the grandchildren will receive an education, the grandparents could set up an irrevocable life insurance trust funded with a second-to-die policy on the grandparents’ lives. That way, the death proceeds would be available to cover the grandchildren’s educational costs after both grandparents are gone.
Some children, even as adults, simply are not good at handling money. While the parents are alive, they can provide financial support to that child. But what happens after both parents are dead?
The solution is for the parents to set up a “spendthrift trust” funded with a second-to-die policy on the parents’ lives. Then, after the parents are gone, the trustee collects the death proceeds and uses the funds to take care of the child’s needs. Under such circumstances, the child’s creditors will not be able to touch the funds in the trust. In addition, to prevent those creditors from taking money given directly to the child, the trustee instead purchases goods and services for the child. For example, the trustee could pay the child’s rent directly to the landlord, preventing the creditors from accessing the rent money.
Some parents hesitate to make charitable gifts because they are concerned their children will resent having a part of their inheritance given away. To deal with this issue, the parents could establish an irrevocable life insurance trust funded with a second-to-die policy on their lives. That way, when the parents die, the children would receive proceeds from the trust, free of income and estate taxes, instead of the property being given to charity.
Parents who own a family business tend to want to treat each child equally. However, some children may not want the business or may not be suited to receiving an interest in the business. That presents a problem if the parents want the children to have equal shares of their estate.
The solution is for the parents to purchase a second-to-die policy on their lives. The child who is not receiving a share of the business can be made a beneficiary of the policy. That way, each child can receive a fair inheritance, with one getting the business while the other receives the life insurance proceeds.
For parents with young children, the greatest risk to the children comes if both parents die. To deal with that risk effectively, the parents can establish a revocable trust, and make the trust the owner and beneficiary of a second-to-die policy on their lives. In that way, if both the parents die, the trustee can collect the death proceeds and provide for the children’s needs from the trust funds.
These examples make it clear that second-to-die policies have uses beyond paying estate liquidity needs. Further, such policies may be issued even when one of the two prospects is uninsurable. In addition, since the death benefit is not payable until the second death, the coverage tends to be more cost-effective than single life policies. The bottom line is that this type of coverage has evolved into being useful for far more purposes than were ever imagined when it initially was developed.
Louis S. Shuntich, J.D., LL.M., is director, Advanced Consulting Group, Nationwide Financial. Louis may be contacted at [email protected]