Life Policies That Pay The Death Tax

If your heirs may not be able to afford the estate taxes on the family homestead or business--and you don't want them to have to liquidate their inheritance--the life-insurance industry has a solution. It's called variable survivorship life, and it's a hot product these days. In the past year, the number of companies offering it has grown from two to seven, including The Equitable, Allmerica Financial, Merrill Lynch, and John Hancock. And this is just the "first wave," predicts Roger Blease, a product analyst at A.M. Best & Co., which rates insurance companies.

Variable survivorship melds two types of insurance: variable universal life and survivorship, also known as second-to-die. The policies cover two people and pay out after the death of the second, so not only is it cheaper than individual coverage but it is a great tool for couples who want to provide their children with cash to pay taxes. Although estates pass tax-free between spouses, other heirs are liable for roughly 55% federal tax (plus more in some states) on the portion of combined estates that exceeds $1.2 million. As part of a properly structured plan, often using irrevocable trusts to keep proceeds out of the estate and to ensure that Mom and Dad's wishes are followed, life-insurance payouts can be free of both income and estate tax.

FLEXIBILITY. The variable universal-life part allows policyholders to oversee the cash value as they would their investment portfolio, choosing among professionally managed subaccounts made up of stocks, bonds, and money-market instruments. Some companies also offer real estate or international funds. Traditional survivorship life policies accumulate cash value only within the insurer's general account, normally a conservative bond-based mix guaranteed to grow at a rate of 4% or 5%. With variable insurance, policyholders can take on more risk--and likely achieve greater long-term results.

Since it is "universal," you get great flexibility over when and how much to pay in premiums. If your investments fare well, the cash value will accumulate tax-deferred, and you will have more money to withdraw or borrow against. You also might be able to stop premium payments sooner or increase the death benefit, depending on the kind of policy you choose. With John Hancock's Variable Estate Protection, introduced in May, policyholders can elect to increase the death benefit as the cash value builds up. That way, the policy's face value can keep up with growth in your estate, assuring that there would be enough funds available to cover taxes, says Elise Coburn, Hancock's variable-life product manager.

There's another advantage to variable life. With fixed accounts, you are technically a creditor of the insurance company, and if it becomes insolvent, you could lose access to the cash value, says Joel Isaacson, a New York City financial planner. Variable accounts, however, are separate from the insurer's general account, so access shouldn't be a problem if the company gets into financial trouble. Since survivorship policies may be in force for 30 or 40 years--and you can't predict how companies will fare that far into the future--Isaacson feels more comfortable putting clients into variable policies.

But what about the risk that your investment choices will go sour? Many policies guarantee a death benefit, so you won't lose coverage as long as you pay enough in premiums. For that guarantee, Hancock requires you to pay a minimum of 85% of the target premium, so you lose flexibility as to when and how much you pay. Although you may have to pay more to get the guarantee and it is not allowed in all states, Blease recommends you choose these policies if available.

HOMEWORK. You can manage investment risk by diversifying, so it is important to choose a policy with several subaccounts , says Lester Lovier, a vice-president at Equitable Life Assurance Co., which offers 13 fund choices. He also recommends looking for policies with good track records and liberal liquidity and transfer rules.

To compare costs, ask your agent to illustrate how the policy would work given varying rates of return. If you invest mainly in equities, you might be able to gross 10% a year on average, but you should subtract about 2% to reflect management expenses of the underlying funds. Other fees vary and may include sales and administrative charges.

Despite the management fees, "for most people, having equity exposure will work out better" than fixed policies, says Isaacson. Adding an element of market risk to a life insurance policy isn't for everybody. But if you like to steer your investments and hate the thought of letting your cash value languish in a fixed account, variable survivorship life may be just what you--and your heirs--have been waiting for. Amey Stone

      For a 60-year-old nonsmoking couple in excellent
       health in New York State
      60      $38,891          $25,774        $3 million
      70      388,910          454,212         3 million
      80      777,820        1,161,143         3 million
      90    1,166,730        2,044,579         3 million
      * Assumes premium of $38,891 a year, although great flexibility is allowed in payments
      ** Assumes an 8% rate of return on policy's subaccounts (6.49% net of expenses)
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