Does Second Death Insurance Create a Tax Profit? not exactly.
“I am thinking of the second person death policy that would come to fruition after my wife and I are gone.
“Here are some suggestions the agent came up with, based on giving premium dollars to a boy-owned trust. I need to work through all the tax wrinkles, but it’s ultimately a series of bets, and most importantly we die after one premium and the boys commit to the insurance company to get The full death allowance After that, the benefit diminishes in size.
“I’d love to hear your thoughts if I dig into them.”
Second Die: A cool insurance policy that magically creates a tax-free bonus for your kids. They can use the money to pay death taxes on the rest of your assets.
However, the timing of the reward does not correspond to the needs of your family. Also: Turns out the tax-free feature isn’t very magical. Also: future premiums are a bit vague.
These policies, sold to a couple about to retire or who are in retirement, have a death benefit that takes effect only upon the death of the second parent. Second to die such a mouth. Can I just say what the agent wants is an STD?
At first glance, the STD tax exemption seems pretty powerful. One element of this is that a life insurance policy death benefit does not constitute taxable income. Thus, if you take a $1 million policy and pay one $10,000 premium, and the next day it’s paid to the subway tracks, your heirs make $990,000 in profit but don’t pay income tax on that profit.
The second key fact about life insurance is that proceeds from your possessions can be kept. The way to do this is to make sure that the policy belongs to the survivor and not to you. This is easy to arrange.
These two tax angles can be perfectly integrated into the sales yard. There is no death duty when you or your spouse dies, because the surviving spouse does not owe estate tax. When both of you are gone, though, the next generation, who will likely owe a raft of estate taxes, has the ones covered by STD policy returns. With the date of a second death probably out of reach, the premiums are low, and much lower than they would be on your or your spouse’s single life policy.
A few decades ago, when death taxes loomed for the upper middle class, these policies created a good business for agents. Notable among them: Barry Kay. He had books, a big advertising campaign, and a thriving insurance agency (call 1-800-DIE-RICH).
Besides, came some tax cuts that took the air out of the dealerships’ sails. The federal estate tax exemption is now $12 million per person, which means a married couple can leave $24 million tax-free for the next generation. Many states have reduced or eliminated death taxes.
But the federal exemption does not last. Much like a wagon that turns into a pumpkin, the exemption returns, at midnight on December 31, 2025, to the $5 million it had under the previous tax code.
Last year, when the Democrats had tighter control of Congress, there was talk of speeding up the deadline and even cutting the $5 million. And so the STDs came back to life.
Your agent has a policy illustration that works like this. You pay $62,000 annually in installments for an expected ten years, after which the policy is paid in full. After you and your spouse die, the policy pays $2.1 million. The children will use the money to cover death taxes on your other assets. (Do you own a yacht or something?) The policy amount will be completely tax free.
To work, the scheme must be arranged like this. You cannot own the policy. It is owned by the children, or more precisely, with a trust on their behalf. They pay the premiums. But you give gifts to compensate them, taking advantage of the $16,000 annual gift tax exclusion.
This exclusion is for every donor, for every recipient. There’s two of you and two of them, so your family can turn $64,000 a year without eating into the gift/estate tax exemption your whole life ($12 million each or $5 million or whatever it’s estimated). Your insurance policy skirts just under $64,000. Deft.
You send money to the children, and they think for two or three seconds what to do with it, and then decide to throw the money into the box. With money on hand, the trust can cover the insurance tab. This charade is blessed with ample legal precedent.
Is this a great deal? not exactly. I have three objections.
The first is about timing. As you note, the big payoff in annual percentage return happens if you and your spouse die young. On the other hand, if you live an actuarial life expectancy double, which in your case is around 35, the policy has an average ROI.
This bonus profile is exactly the opposite of what your family needs. If you die young, your children won’t need an insurance bonus because you won’t spend much of your retirement savings. On the other hand, if you live to 92 and your spouse to 94, either way with greasy nursing home bills at the end, your assets will be exhausted and $2.1 million would be too little, in hindsight.
The next thing I object to is the idea that life insurance creates tax wealth. If you want to pay $62,000 a year tax-free for the little ones, you can do so without involving an insurance company. Just send them money. (I gather they are unmarried and in their twenties.) Tell them to use that to buy growth stocks — or buy a house.
Yes, insurance portfolios have tax breaks of some sort. Earnings within an insurance company that help pay for death benefits (called an “internal accrual”) are largely exempt from tax. But the tax benefits of growth stocks and homes are equally good, and children lose those benefits if they invest in life insurance.
The latter problem is a common one in any life insurance other than the simplest type of insurance policy. What you have in this document about premium levels is not a contract but a ‘expectation’. How long you have to go in order to keep a global policy in effect is subject to a lot of unknowns – future mortality rates, overhead costs, and portfolio returns.
Only one of these factors can be explained, to some extent: if you choose a fixed-income investment, rather than one of the complex options associated with the stock market, then the portfolio return is guaranteed at least 1%. Well, if you want a guaranteed 1% yield, get some US Treasuries. They are much less certain.
What happened to Barry Kay? His company, now in the hands of his son, is advancing strongly. He lived 91 years, so if he buys life insurance, he probably won’t get much return on it.
Do you have a personal finance puzzle that might be worth a look? It could include, for example, lump sums for pensions, Roth accounts, estate planning, employee options, or the sale of assessed stock. Send a description to williambaldwinfinance — at — gmail — dot — com. Put “Query” in the subject field. Include first name and residence status. Include enough detail to create a useful analysis.
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