Plan Carefully Before Buying 'Last-to-Die' Insurance

It can cover your estate-tax burden, but first you have to figure out what that burden might be.
Publish date:

I get a lot of emails with questions about estate planning and insurance. The one below highlights some critical issues:

My broker (recently turned financial planner) is recommending that I purchase "last-to-die" insurance so that my children are not hit with a big tax bill after my wife and I die. But, after reading your columns (Credit Shelter Trusts Leave More For Your Heirs and For Estate Planning, A GRAT Can Be Where It's At), I am questioning my broker's recommendation to buy the insurance based on my total wealth. It seems I should buy the insurance based on what's left over after deducting credits from credit shelter trusts, etc., rather than my total wealth. Any help would be greatly appreciated.

-- Ron Kaplan

This letter goes to the heart of a couple of my pet peeves. First, anybody who tries to sell an insurance policy without first identifying the drawbacks and all the noninsurance solutions should be thrown out of the business! Otherwise, the advice is probably worthless and self-serving. Secondly, anyone, broker or otherwise, who calls himself a financial planner and isn't at least working on becoming a certified financial planner is probably not a planner. Yes, there are exceptions, but they're rare.

So Ron, before you buy any life insurance, do all the planning and tax-savings measures you can with your attorney. After that, if you still have an estate-tax problem, then take a look at life insurance to cover the cost.

The second-to-die policy is also called last-to-die or survivorship life. The strategy is to eliminate all tax at the death of the first spouse. In its simplest form, this can always be done by using the unlimited marital deduction. That means you can leave all you want to your surviving spouse without paying any estate tax.

But that is not always the smartest thing to do. When the second spouse dies, there could be a significant estate tax if everything ended up in that spouse's estate. And since estate tax will be due upon the second death, it generally makes sense to have the life insurance payable on the second death so it can cover the estate-tax obligation.

Your attorney will probably suggest you set up an irrevocable life insurance trust to buy the insurance so the proceeds will not be included in the survivor's estate when he or she dies. You can then make gifts into the trust so the trust can pay the premium. There are important details to work out with your attorney on this.

Second-to-die policies are considered a lot less expensive than policies on a single life because an insurance company can spread the mortality cost over two lives, and in most cases, over a longer period of time. The premium has to be paid until the last person dies. It is generally a lot easier on the budget to pay a lower premium, even if it's over a longer period.

Let's assume a couple, Ann and Scott, are in their 50s and have an estate-tax problem. After planning with their attorney, they have estimated what inflation will do to the value of their estate and have calculated their potential tax burden and the expenses related to settling their estate. They buy a second-to-die policy sufficient to pay these estimated costs. Ann and Scott feel like they've covered all the bases.

Here are some issues they had to settle after putting the framework in place with their attorney:

  • They had to find a good insurance agent.
  • They had to decide what kind of insurance policy to use. Should it be term, whole-life or variable-universal? (For some background on the differences, see my May 17, 1999, column.) They chose the variable-universal life.
  • They had to compare the costs of various policies. The difference in premiums was significant.

The insurance agent will no doubt paint a pretty picture on how the second-to-die policy completes the estate-planning picture and saves thousands of dollars. But there are a couple of issues the agent may not cover with Ann and Scott:

  • What if they get divorced? If this isn't thought out in advance, it can become very expensive and complicated. If the policy is set up in an irrevocable trust, there's probably a provision for dividing the policy in two. Each spouse can own one half the original face amount. But one or both spouses may determine after the divorce that the policy isn't needed anymore.
  • What happens when the first spouse dies? The surviving spouse must continue to pay the premium or the policy will lapse. But what if the surviving spouse is not earning any money and can't pay the premium? If there are adult children, maybe they would help pay the premium. If the policy lapses, the government will get its part of the estate but the kids won't.

So Ron, you asked a great question and I gave you a general answer. To get really specific I'd have to fill a short book. The key is to meet with a good estate-planning attorney. The last-to-die policy could be a good answer, if you still end up with a tax problem after meeting with the attorney.

Have a great week!

Vern Hayden is a certified financial planner in Westport, Conn. He is a financial consultant and advisory associate of Financial Network Investment Corp. He also is an owner of Hayden Financial Group. His column is not a recommendation to buy or sell stocks or to solicit transactions or clients. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. While he cannot provide investment advice or recommendations, Hayden welcomes your feedback.