Inheritance Taxes and Sibling Rivalry
Two of the primary uses of life insurance are income replacement in the event of the death of a family wage earner, and family wealth transfer upon the death of an older generation. While a term life insurance policy is an excellent tool for disaster management in the face of the death of working parent, it is generally a terrible tool for preserving a family’s wealth and transferring it to the next generations. The next time you leave home and drive to the market, take a look around at the wealth that surrounds you. Every home that you see, a every small shop, restaurant, gas station, office building or parking lot represents a slice of some family’s wealth. For most families a fundamental goal of their family’s financial planning is preserving those assets and passing them down to the younger generations. Unfortunately, transferring an real asset like real estate or a business generally creates an immediate need for significant liquidity (that means cash to you and me.) When a business owner or property owner dies, the immediate cash requirements can include direct costs like estate taxes, legal fees and accounting and business valuation costs. Even more significant can be the need for adequate cash in the estate to allow division amongst several children without forcing the sale of the property or business to find the needed cash. If one child wishes to live in the family home, or run the family business, they often need to mortgage the asset or borrow heavily to generate enough cash to fund an inheritance for their siblings. When it isn’t possible to borrow enough, the other siblings will often force a liquidation/sale to generate the cash needed for a fair distribution. Usually that cash need is far greater than what the business or real estate can generate out of operating cash flow. Often, a family patriarch and matriarch build wealth to leave to their children, and rather than a blessing they end up bestowing hostility and frustration. In many cases, the most effective tool to provide liquidity in an estate to pay taxes and costs and to allow for distribution is a permanent life insurance policy. Since the estate transfer doesn’t happen until both spouses of the older generation pass, one potential tool to use for estate planning liquidity is a Last to Die” insurance policy. Last to Die insurance is sometimes called second to die, or more formally, Survivorship life. A Last to Die Life Insurance Policy, is a joint life insurance policy that pays a death benefit only when the second insured dies. Because current federal estate tax law allows an unlimited marital deduction between spouses, an estate can pass from the first to die to his or her spouse with no federal estate tax liability. When the surviving spouse dies, however, estate taxes are generally due, the property transfers generations and without proper planning the bottom falls out on everybody. . Because the insurance company does not pay a death benefit under the policy until the second death, the cost for a survivorship policy should always be less than the cost of one policy of the same face amount on either of the two individuals. A survivorship life insurance policy, or Last to Die policy is especially effective for estate planning if one of the spouses is either difficult or impossible to insure. The two most common types of survivorship life insurance are whole life and universal life. Some companies also use a blend of whole life and term insurance. However, the higher percentage of term that is “blended” into the policy, the more sensitive the total policy is to slight changes in dividends or interest rates. Survivorship life insurance covers two lives, usually, a husband and wife. The policy pays out upon the second death. Because of the unlimited marital deduction instituted by congress in 1981, individuals with estates large enough to incur an estate tax liability often structure their holdings in such a way that they delay the payment of any estate taxes until the second spouse’s death. A second-to-die contracts allow the insurance company to delay the payment of the death benefit until after the second death as well. By aligning the payment of the death benefit with the imposition of the estate tax and the associated cash needs of the intergenerational asset transfer the survivorship life policy eases the transition, and helps the family preserve the assets that their elders worked so hard to build.