Survivorship life insurance, also referred to as second-to-die life insurance, has been primarily used for estate planning needs. With proper design and planning, a survivorship life insurance policy utilized for estate preservation can ensure estate taxes are covered and the estate’s assets are preserved for heirs. For many years, the ideal survivorship life insurance product for this design has been guaranteed survivorship universal life (GSUL), which offers a guaranteed death benefit for a designated duration (e.g., to the younger insured’s age 100).
Although estate planning continues to be a valuable use of this product, particularly for the wealthy marketplace, market pressures have led to less competitive and less attractive GSUL products.
In 2012, the National Association of Insurance Commissioners adopted revisions to Actuarial Guideline 38 (AG38) that focused on increased reserving requirements for guaranteed products. That led to price changes for many products, the majority of which were price increases. Some carriers opted to discontinue products, and some decided to completely exit the guaranteed marketplace, limiting the available GSUL product offerings.
Since then, sustained low interest rates have led many carriers to make additional price increases to their GSUL products, and many have placed premium restrictions on these products, further limiting their competitive scope.
Beyond product pricing and product offering issues, the life insurance marketplace has been impacted by tax law changes that have increased liabilities for most taxpayers. The top income tax rate is now 39.6 percent (up from 35 percent), and the top rate on long-term capital gains and qualified dividends is 20 percent (up from 15 percent). The federal estate and gift tax rates were also increased from 35 percent to 40 percent. Additionally, in 2013 a new Medicare surtax was introduced that adds a 3.8 percent tax on the lesser of net investment income or excess of modified adjusted gross income over specific thresholds.
The lingering uncertainty over the economy has also shifted consumer views regarding the need for life insurance and its application in today’s economic environment. The “LIMRA Consumer Sentiment Tracking July 2013 Update”noted that “slightly more than half of Americans (54 percent) have an unfavorable view of the economy — the lowest percentage since LIMRA started tracking consumer sentiment in March 2008.” It also noted that “the worse people feel about the economy, the more concerned they are about their own financial well-being.” For this reason, many consumers are seeking out alternative strategies to plan for their financial well-being, not just that of their heirs.
All of these changes have shifted how survivorship life insurance is being utilized, as well as the demographic being attracted to this product. Due to its popularity as an estate planning tool, SUL was generally seen as best suited for older insureds. However, it also has valuable applications for today’s younger insureds.
One area in which survivorship life sales have experienced growth is the cash accumulation space, utilizing products like current assumption SUL and indexed SUL. Although these products still offer the main benefit of life insurance — death benefit protection — they also offer cash value accumulation that can be used for multiple needs. Here are three.
Need: Retirement income
The “LIMRA Consumers’ Retirement Perspectives Fourth Quarter 2012” report noted that “only 1 in 5 working consumers — and only 1 in 4 of those age 55 or older — is saving 10 percent or more of their annual income for retirement.” It also stated that “the vast majority of workers (80 percent) believe they need to save more to be on track for retirement.”
In many cases, those saving for retirement are doing so via vehicles like a 401(k) or an individual retirement account. And although these are great retirement savings tools, they are potentially subject to taxation, as any gain in these accounts is considered ordinary income when the funds are withdrawn.
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For this reason, many financial advisors that understand the tax advantages of life insurance recommend their clients use a cash-accumulating life insurance contract to supplement their retirement income. Any cash accumulation within a life insurance policy is grown on a tax-deferred basis, and in the majority of cases, these earnings can be accessed by the policyowner income-tax-free. (For more information on tax treatment of life insurance policies, see Internal Revenue Code (IRC) Sections 72(e)(1), 72(e)(5)(C) and 101(a)(1).)
Most advisors will recommend an individual or single-life insurance policy when structuring this design for their clients; however, there are certain circumstances in which a survivorship policy could be a better option. This is particularly true when one insured is healthier than the other, especially if one of the insureds is considered “uninsurable” based on carrier medical underwriting guidelines. This can also be the case if one insured is significantly younger than the other.
Depending on the competitiveness of the product being used and how the policy is structured, using a cash-accumulating survivorship product can potentially provide insureds with a higher income return than taking income from an individual life policy. For many scenarios, this holds true even if that individual policy was taken out on the healthier and/or younger insured. This occurs because premiums for a survivorship policy are based on the joint life expectancy of the insureds, resulting in improved mortality assumptions. The charges associated with a survivorship policy are generally lower than those within an individual policy. This lower charge structure allows the policy to accumulate cash value at a faster pace, hence the potential higher income availability.
This design can also be attractive to younger insureds who may not have the cash flow to fund two separate policies that can provide the desired death benefit and returns. With a cash-accumulating survivorship policy, they can take advantage of the lower charge structure to: 1) purchase a higher death benefit amount that would provide protection to their estate and heirs, 2) accumulate cash value on a tax-deferred basis that can be used to supplement their retirement, and 3) create flexibility for their future via a policy whose cash value can be transferred to another life insurance policy if their needs change over time and there is a better-suited product, or surrendered if they were to decide they no longer need the policy.
Need: College planning
Along the same lines of income opportunities from a life insurance policy, another valuable use for cash-accumulating survivorship life insurance policies is college planning. The U.S. Department of Education, National Center for Education Statistics, reported that “between 2000–01 and 2010–11, prices for undergraduate tuition, room, and board at public institutions rose 42 percent, and prices at private not-for-profit institutions rose 31 percent.”
The cost of college education continues to rise every year, and although various financial vehicles are available to help parents plan, many of these options are not flexible and only offer benefits on a restricted basis. For example, one of the most popular education savings plans is a 529 plan, which is a tax-advantaged program administered by state agencies and authorized under IRC Section 529. These plans allow investors to save money on a tax-deferred basis, and distributions from these plans that pay for qualified college expenses are federal income tax free. However, with a 529 plan, there are several restrictions and guidelines that need to be considered, such as:
- At the time of withdrawal, there may be state taxes imposed.
- Each state that offers a 529 plan determines how its plan is structured and which investment options are available.
- Each 529 account can only have one beneficiary.
- The funds can only be used for “qualified higher education expenses” at an “eligible educational institution.”
- If the funds are not used for college, any withdrawals from the account that are considered earnings — not contributions — will be subject to federal and state taxes plus a 10 percent federal tax penalty on the earnings.
- If the beneficiary receives a scholarship but still wants to withdraw funds from the 529 plan that will not be used to cover “qualified higher education expenses,” the earnings (not contributions) on the amount withdrawn would be taxed at the scholarship recipient’s tax rate, but will not be subject to the 10 percent additional federal tax penalty.
- Federal law prohibits the investor from having direct control over the selection of specific investments in the 529 plan. Therefore, the state and the investment manager (if the state has chosen to work with one) typically offer multiple savings options for investors to choose from when they open an account. The account owner may change investment options subject to certain federal tax law limitations.4
Other college savings vehicles have similar, or even more rigorous, guidelines. For parents who want more flexibility with the money they have allocated for college planning, a cash-accumulating survivorship policy may be a better option.
A cash-accumulating survivorship policy can also be used to supplement other college savings plans already in place. In the same manner that the insureds would take income from a survivorship policy for retirement, they can take income to fund their children’s college expenses, while taking advantage of the improved mortality assumptions and competitive charge structure that an individual policy would not offer. In many cases, college-funding income will be needed sooner than retirement income. Therefore, a survivorship product designed for earlier cash accumulation would be the best-suited product.
The advantages of using a cash-accumulating survivorship policy for college planning are: 1) tax-deferred cash accumulation with the potential for tax-free withdrawals, 2) funding flexibility with no minimum or maximum requirements, 3) ability to use funds for more than one child’s college expenses, 4) funds can be distributed to the children at the parents’ discretion without any limitation and 5) the policy owner has full control over the policy’s investment allocations (subject to policy restrictions).
The death benefit associated with these policies can also be considered an advantage because it offers an additional level of financial protection beyond traditional college savings plans. If both parents die, and the child (or children) was designated as the beneficiary(s), they would still benefit from this contract via the death benefit that would be paid out and that could be used for any financial needs they may have (i.e., college expenses, living expenses).
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One very valuable additional benefit a survivorship policy can offer is that if the cash value within the policy is never needed for college planning, the insureds can always opt to use that money for other needs, or choose to keep the policy in force and have it pay out the death benefit at the death of the second insured.
Need: Living benefits
One serious threat to a large segment of the population is not having sufficient retirement savings to cover living expenses without substantially decreasing standard of living. In these cases, the retiree may have planned properly for retirement and had savings in place intended to provide a comfortable lifestyle during retirement; however, due to varying issues, those savings no longer cover their needs.
The Center for Retirement Research at Boston College reports that “the percentage of U.S. households at risk of being unable to maintain their standard of living in retirement rose from 30 percent in 1989 to 51 percent by 2009.” The most recent report from the National Retirement Risk Index indicated that, in 2013, this percentage is now 53 percent.
This risk has increased for several major reasons, including rising life expectancies due to better health care, unexpected age-related health issues, increased cost of health care and decreased net worth due to the economic downturn that impacted investment accounts. Other everyday consumer risks or concerns for people of all ages include job loss, unexpected disability, unplanned long-term care needs, emergency medical expenses not covered by traditional health care, business venture failures and overall inability to pay financial obligations and debts.
Due to its flexibility, a cash-accumulating survivorship life insurance policy can alleviate these risks and fund multiple needs that could arise during the insured’s lifetime. The improved mortality assumptions of a survivorship policy make it an affordable addition to an existing life insurance portfolio, permitting this policy to be viewed as a rainy day fund, while maintaining its unique advantage of providing a death benefit to the beneficiary(s). Or, if the insured’s financial situation does not support multiple policies, a cash-accumulating survivorship policy could be purchased as the primary life insurance plan for the estate since it can provide estate planning, cash accumulation, future flexibility and death benefit protection.
Overall, a cash-accumulating survivorship life insurance policy can be a very flexible contract available for multiple needs. Its primary purpose is to provide death benefit protection, the foundation of all life insurance policies, and it will continue to be a strong solution for estate preservation planning. However, if structured properly, a cash-accumulating survivorship policy can go beyond death benefit protection and be a valuable resource for additional financial needs during the insured’s lifetime.
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