Survivorship Policies: What You Should Know Before Using One As An Investment

Many reasons exist for why an investor might sell an investment, such as the loss of a job, a death in the family or a major purchase. But there is only one reason a person invests, and that's to make money.

At times, emotions can dictate the type of investment or the lack thereof that we choose. Mistakes are often made when we act emotionally, which is why we must act logically. A sounder way to invest is to focus on the expected outcome, which boils down to math. 

When considering investments, many people tend to think of traditional ones, such as stocks and bonds. But life insurance can be used for investment purposes, too.

One option people have is to contribute to a life insurance policy on the first or second generation before them, such as their parents or grandparents. This type of policy is called a survivorship, formerly known as second-to-die. Below are some key factors to consider when deciding whether to put your money into a survivorship policy instead of a more traditional investment account.

A survivorship is generally believed to be more cost-effective than one on an individual because it pays out once but is on two lives and is typically based on the healthier of the two. To be clear, for a survivorship policy to pay out, both of the insureds must be deceased. When one's parents are close in age and their health conditions are considered to be the same, survivorship may be a better choice than an individual policy since it may be more cost-effective.

However, if the parents have a larger than average age gap or vast differences in health, then an individual policy could be a better choice. The reason for an individual policy in such a situation is simply that the insured who is older or unhealthier may pay out sooner than a policy that pays out after both insureds die.

Life insurance death proceeds are guaranteed to pay out as long as the policy is in force, or active. These proceeds will most likely be tax-free rather than tax-deferred, as long as the rules of the insurance department were met. For pennies on the dollar, one is able to leverage the return of an investment. 

As with any investment, survivorship policies have potential drawbacks to consider. Any life insurance policy must be in force upon death, which means that if someone were to pay for a policy for 20 years and then stop contributing, the policy could lapse and lose not only what would have been the death benefit but also all the premiums paid. When securing a life insurance policy for this purpose, one must remember that premiums will always have to be paid. 

Here's how this kind of policy works in an example of a 40-year-old. Rather than a traditional type of investment such as a brokerage account where, for example, $20,000 per year is being invested, that same investment would be used to pay for the premiums to purchase a policy on that person's parents, who are 70 and 72. The premium of $20,000 purchases $1 million of life insurance. If the parents died at the ages of 93 and 95, the actual return on the million-dollar death benefit may be as high as 7% before taxes. If the same $20,000 was invested in a brokerage account and the investor's tax bracket was 30%, the equivalent yield to the 7% tax-free would be approximately 11% in a taxable environment. To expect to earn 11% a year for 23 years in any other investment would be unusual.

When deciding whether a survivorship policy could be a fit for you as an investment rather than putting money into a traditional investment account, there are other factors to consider, as well. Before applying for life insurance of any kind, there must first and foremost be a need for the insurance other than just as an investment. Other things to consider include the ownership of the policy, the potential existence of a trust and your budget. One tip when determining how much life insurance you can afford is to work backward: First, determine whether there is a need for the insurance and an insurable interest (parents and children satisfy that rule). Then look at your budget, and purchase as much life insurance as the budget allows. Investing in life insurance should be reserved for those who can do without the liquidity and who have the ability to continue to pay premiums. 

However, a traditional type of brokerage account has its own advantages, too. For example, an investor can invest as much or as little or at any time they want, and their investment will always be there, assuming the underlying investment doesn't go bankrupt. A brokerage account will most likely be liquid and not dependent on anyone's mortality, too. In addition, with insurance, if a policy is in force for several decades, the return in that situation would likely be greater in a brokerage account due to the continued expenses of the insurance for an extended period of time.

To determine whether a survivorship policy over a brokerage account might be a good choice for your situation, speak with an advisor who has experience in this area and is willing to speak with the owner and insured.

This article originally appeared on Forbes.


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