Why we need flexible design in estate planning

A SPO provides that, upon the death of the primary insured, the surviving beneficiary (the insured beneficiary) has the option at that time to purchase life insurance without evidence of insurability. In addition to the primary insured, the insured beneficiary is also underwritten at issue of the original policy. 

If the primary insured dies before the insured beneficiary, the insured beneficiary can:

1. Receive the policy death benefit and spend the money as her or she pleases, or
2. Partially or fully use the policy death benefit to exercise one of the following guaranteed options to purchase insurance on the insured beneficiary’s life:

• a whole life policy at the attained age with ongoing premiums;
• a single-pay, paid-up whole life policy at the attained age; or
• a whole life policy at the original issue age when the SPO rider was purchased. The new policy will have values as if it had been in force since the original issue age. In order to activate this option, the premium rate based on the original issue age and underwriting class must be paid. The cash value effective the anniversary following the primary insured’s death must also be paid. This cash value is known as point-in-scale cash value.

Under each option and regardless of how much time has elapsed, the insured beneficiary receives the same rating classification determined at policy issue. A change in health conditions cannot adversely affect premium amounts due.

One technique used with SPOs in estate planning is to purchase an original policy on each spouse with an SPO rider in favor of the other spouse on each policy. The policy owner names the spouse as the primary beneficiary and an ILIT as the contingent beneficiary of the policy.  Because the insured is the owner of the policy on the insured’s life, the insured can change the primary and/or contingent beneficiary of the policy any time prior to death. Thus, if circumstances change (as they did for Frank and Martha), the insured has flexibility in being able to make changes not ordinarily available with traditional irrevocable survivorship policy planning. 

See also: 3 ways survivorship life can help younger clients

At the policy owner’s death, the surviving spouse beneficiary may disclaim some or all of the policy death proceeds. The surviving spouse may also disclaim the SPO purchase right. Any disclaimed proceeds and the disclaimed SPO purchase right then devolve to the ILIT. This arrangement permits the surviving spouse to decide at the insured’s death how much, if any, of the death proceeds the surviving spouse needs. The ILIT trustee can decide how much, if any, of the SPO rider to exercise.

Editor’s Note: All names and examples are hypothetical and have been used for explanatory analytical purposes only.

See also:

• 13 ways an annuity can benefit an estate plan
• 4 ways insurance can protect your clients’ retirement funds
• 6 trusts you should know about