Tax Treatment and Gift Considerations for Survivorship Policies in Wealth Transfer

Survivorship (second‑to‑die) life insurance is a cornerstone strategy in high‑net‑worth (HNW) estate planning because it can create large, tax‑efficient liquidity for estate taxes, fiduciary expenses, and equalization among heirs. This article explains the federal and state tax mechanics, gift and funding techniques (including ILITs and Crummey gifts), valuation pitfalls, and practical pricing examples for HNW families in the United States — with a focus on New York, California, and Texas markets.

Why survivorship policies are used in HNW wealth transfer

• They pay only once — on the second insured’s death — which lowers premium vs two single‑life policies for the same combined face amount.
• Death proceeds are generally income‑tax free under IRC §101.
• When properly structured (e.g., owned by an irrevocable life insurance trust — ILIT — without incidents of ownership), proceeds can be excluded from the insureds’ federal and many state taxable estates.

For a broad primer on how these policies fund estate taxes and preserve family wealth, see Survivorship Life Insurance Explained: Funding Estate Taxes and Preserving Family Wealth.

Federal tax fundamentals (gift, estate, income)

• Income tax: Death benefits are generally income tax‑free to beneficiaries under IRC §101(a).
• Estate inclusion: Proceeds are includable in a decedent’s gross estate if the decedent owned the policy or retained “incidents of ownership.” Transfers within three years of death are pulled back into the estate under IRC §2035.
• Gift tax: Funding an ILIT or making premium gifts may trigger gift tax rules. Annual gift tax exclusion (present interest gift) allows up to the IRS annual exclusion per donee without using lifetime exemption; for current figures and FAQs see the IRS guidance on estate and gift taxes. IRS: Estate and Gift Taxes FAQ

Important planning controls:

• Use an ILIT with Crummey powers to convert premium transfers into present interest gifts that qualify for the annual exclusion.
• Avoid transferring a personally owned policy to an ILIT within three years of death to prevent §2035 inclusion.
• Consider portability of a deceased spouse’s unused exclusion amount, but note portability alone is risky for long‑term estate planning for very large estates.

Gift mechanics: funding premiums and Crummey notices

• Typical ILIT funding strategy: grantor makes a cash gift to the ILIT each year equal to the premium. The trust’s trustee issues Crummey withdrawal notices to beneficiaries, giving them a short window (normally 30–60 days) to withdraw the premium amount — this converts the gift into a present interest gift eligible for the annual exclusion.
• If a family has multiple Crummey beneficiaries, the annual exclusion can shelter a larger premium without dipping into lifetime exemption.
• If premium amounts exceed what can be sheltered by annual exclusion gifts, the grantor may apply part of their lifetime estate/gift tax exemption.

See practical ILIT interactions here: How Survivorship Policies Work with ILITs and Trust Structures for HNW Estates.

State estate tax considerations (New York, California, Texas examples)

• Federal exemption is large (and indexed annually). State estate tax regimes vary: New York and Massachusetts levy estate taxes with much lower thresholds than federal; California and Texas have no state estate tax.
• Example considerations:
  • New York: New York imposes a state estate tax with an exemption significantly lower than the federal level, so New York executors often rely on survivorship coverage to fund state taxes and bridge the gap.
  • California: No state estate tax, but liquidity is still needed to settle estates; using survivorship policies in CA often focuses on equalization and charitable bequests rather than state tax avoidance.
  • Texas: No state estate tax, but family business succession planning in Texas commonly uses survivorship coverage to provide liquidity for buy‑sell funding.

For an overview of state estate and inheritance taxes (thresholds and presence by state), see the Tax Foundation’s survey: State Estate & Inheritance Taxes.

Ownership structures — tax outcomes (comparison)

Key point: Proper trust drafting, trustee independence, and avoidance of retained incidents of ownership are essential to keep proceeds out of the taxable estate.

Pricing and carrier examples (market context)

Carriers commonly used by HNW planners include New York Life, Northwestern Mutual, MassMutual, Prudential, and John Hancock. Product choices are typically survivorship universal life (SUL), survivorship term (less common for permanent planning), and survivorship guaranteed universal life.

Estimated market pricing (illustrative ranges for planning — obtain carrier quotes for underwriting specifics):

• Healthy couple age 55/55, $5 million SUL: annual premiums commonly quoted in the $15,000–$45,000 range depending on product (guarantee features, cash value funding, underwriting).
• Healthy couple age 65/65, $5 million SUL: premiums may rise to $35,000–$85,000 annually for guaranteed features.
• Insurers like New York Life and Northwestern Mutual emphasize non‑cancelable features and typically price at the higher end of the market; mass‑market carriers (e.g., Prudential) can offer more competitive spreads depending on underwriting.

For practical product analysis of survivorship policies, see Investopedia and Policygenius:

• Investopedia overview: Survivorship Life Insurance — Investopedia
• Policygenius primer: What is Survivorship Life Insurance? — Policygenius

Always obtain in‑force illustrations and multiple carrier quotes; small changes in issue age, tobacco status, and guaranteed vs nonguaranteed crediting assumptions produce large differences in long‑term cost.

Common planning pitfalls and mitigations

• Retained incidents of ownership: If a grantor retains powers (e.g., ability to change beneficiaries, borrow, or surrender), the policy proceeds may be included in the grantor’s estate. Mitigation: trustee holds all incidents of ownership; grantor has no power to revoke or direct investments.
• Three‑year rule (§2035): Transfers to an ILIT within three years of death are includable. Mitigation: implement early, ideally years before expected estate settlement events.
• Premium funding shortfalls: If ILIT lacks liquidity to pay premiums, trustees could be forced to borrow or to lapse the policy. Mitigation: design trusted cash flow funding (annual Crummey gifts, term riders, or hybrid funding sources).
• State tax traps: Where state estate tax thresholds are lower than federal, plan specifically for state‑level exposure with localized counsel.

For guidance on designing coverage amounts and premium strategies for very large estates, consult: Designing Survivorship Policies for Large Estates: Coverage Amounts and Premium Strategies.

Practical next steps for HNW families in NY, CA, TX

1. Run estate tax projection models including state exposure and portability scenarios. (See modeling examples: Real‑World Scenarios.)
2. Obtain preliminary carrier illustrations from at least three firms (e.g., New York Life, Northwestern Mutual, Prudential) for the desired face amount and guarantee levels.
3. Engage estate counsel to draft an ILIT with appropriate Crummey language and independent trustee provisions; confirm timing to avoid §2035.
4. Coordinate with financial advisors on available cash flow to fund annual premiums versus using larger initial gifts or limited pay designs.

Prepared, well‑documented survivorship solutions deliver liquidity, preserve estate exemptions, and reduce forced asset sales — but they must be executed with careful trust drafting, state‑level tax analysis, and competitive carrier pricing to succeed.