When George W. Bush took the oath of office as president last month, opponents of the estate tax issued a collective sigh of relief. It appears, they say, the so-called death tax is on the way to its own demise, or at least to being modified with increased exemptions that will greatly reduce the number of estates that have to pay it.

Whether an almost equally divided Congress will let Bush deliver on his campaign promise to repeal the estate tax remains to be seen, although most members of the 106th Congress of last year supported some kind of estate-tax reform. Either way, financial advisors say, the need for second-to-die life insurance, also known as survivorship life, as a tool for paying off estate taxes will be diminished greatly, if not eliminated.

Second-to-die insurance has become big business. The life insurance industry could take a $1 billion hit if high-net-worth individuals and their financial advisors turn their backs on second-to-die insurance, according to the Life Insurance Marketing Research Association, which says second-to-die insurance accounts for about 8% of all new life insurance premiums.

Policy owners would take a hit, too, if the insurance becomes unnecessary. Proceeds from second-to-die policies, which pay benefits on the death of the spouse who dies last, are used by beneficiaries to pay estate taxes and preserve their inherited assets.

"I think a lot of people are going to learn what the concept of 'sunk cost' really means now," says Rick Adkins, CEO of the Arkansas Financial Group, in Little Rock. "We often find people have no actual need for the death benefit of a life insurance policy. You have to evaluate it from a purely financial standpoint. What is the benefit of retaining the coverage? We run a present-value cost-benefit analysis. If there's no benefit, we advise them to drop the coverage. If you don't need it anymore, and you can't go back and get that money, you have to cut your losses and move on. What's been spent has been spent." For many, especially those who still have a long life expectancy, the only logical choice will be to surrender the policy for its cash value and take the loss.

While some say estate-tax repeal would sound the death knell for second-to-die insurance, others say it still can play a valuable role in business succession and dynasty planning.

Second-to-die insurance has become the product of choice for taxpayers seeking to protect their heirs from estate taxes. Survivorship life policies were first developed in 1961. But they became popular after the passage of the Economic Recovery Tax Act of 1981 (ERTA), which created an unlimited marital-tax deduction that allows assets to be left to a spouse without taxes having to be paid until after the spouse dies. Since ERTA became law, survivorship insurance has grown steadily and, in recent years, more rapidly. Second-to-die insurance generated policies with average death benefits of $1.9 million and average annual premiums of $28,000 during the first half of last year. For insurance companies that focus on high-net-worth individuals, second-to-die insurance can account for one-quarter to one-third of all new premiums, says Elaine F. Tumicki, assistant vice president of industry performance research at Windsor, Conn.-based LIMRA.

Views On Estate Taxes

Harold I. Apolinsky, an Alabama attorney and estate planner with the Birmingham-based law firm of Sirote & Permutt, has lobbied for repeal of the estate tax for many of his 35 years in the profession. He is guardedly optimistic that Congress will repeal the tax this year. Apolinsky points out that 500 of the 535 members of Congress last year voted for some kind of estate-tax relief. HR-8, which wouldhave increased the estate-tax exemption incrementally to $1 million per person in 2010, after which it would be eliminated, passed both the House and the Senate last June, although former President Clinton refused to sign it. The challenge now, Apolinsky says, is repealing the estate tax early this year. "If you had to wait 10 years, I would simply sell my clients a diet and exercise program," he says. "If the estate tax is repealed, second-to-die insurance will go away. But there still will be significant amounts of life insurance sold to take care of debt. You still need classic key-man insurance and insurance for business succession."

Ben G. Baldwin Jr., CLU, ChFC, CFP, believes an increase in the exemption for estates is more likely than repeal. Baldwin, who owns the Northbrook, Ill.-based Baldwin Financial Systems Inc., is the author of five books on insurance, including "The Complete Book of Insurance: A Consumer's Guide to Insuring Your Life, Health, Property & Income."

If Republican-proposed legislation eliminating the step-up in cost basis for investments passes, Baldwin says, it could create another reason to buy second-to-die insurance. "Instead of buying mutual funds, you could buy them inside of a variable universal life second-to-die policy and enjoy a step-up to the entire policy value without taxation," he says. Still, as Apolinsky sees it, if the exemption were raised to $5 million, only 2,898 estates of the 48,000 that had to pay death taxes in 1998 would have been required to pay, cutting the need for second-to-die insurance to cover estate taxes dramatically.

Sheryl Rowling, a CPA and PFS with Rowling, Dold & Associates in San Diego, sees a third possible scenario in which the estate tax and the step-up in basis both are eliminated. "That would require a whole new outlook on the planning process to determine how to pay the capital-gains tax when the beneficiaries sell the assets of the estate," Rowling says.

For example, in 2010 the estate of a couple that includes a beach house purchased for $200,000 years earlier but by then valued at $3 million would pay estate taxes on about $1 million (each spouse gets a $1 million exemption), for a tax bill of about $500,000. However, if both the estate tax and the step-up in basis are eliminated and their children sold the house, they would have reportable income of about $2.8 million and probably would have to pay $600,000 to $700,000 in capital-gains taxes and state income taxes. "In that example," Rowling maintains, "second-to-die insurance would be just as necessary."

Unwinding The Money

All types of second-to-die policies, except those written under term-life policies, which Baldwin says are few, can be surrendered for the cash value of assets in the policy. But that may be little consolation to people who have paid into the policies for long periods of time or ponied up large initial payments on their policies to reduce sales commissions and premiums. Those policyholders undoubtedly will look at the money they have paid in premiums versus the alternative investments they could have made. And, as is the case with an irrevocable trust, the trust or its beneficiaries own the policy. Surrendering the policy will provide the beneficiaries the cash value. The grantor of the trust will not get the money back to use for other investments that might produce better returns for the eventual heirs.

"Second-to-die policies usually are written inside of irrevocable trusts so you can't get the money. It may be written into some that you can, but the key word there is irrevocable," says John Henry McDonald, CFP and president of Austin Asset Management Co. in Austin, Texas.

McDonald likes second-to-die policies and says he uses them whenever he can. However, the thing that makes them attractive for avoiding estate taxes makes them look a lot more like sunk costs if the estate tax is repealed. By writing the second-to-die policy in a trust or a policy that is owned by the beneficiaries, high-net-worth individuals have been able to take the death benefit out of their estates so it will not be subject to estate taxes. "But if you no longer need it and you want to put the cash value into another investment," he says, "you're not going to be able to get the money out."

For some, it makes sense to retain second-to-die policies. For older couples who have been paying into their policies for many years, second-to-die insurance may play a role comparable to bonds in producing stable, steady returns. For couples over 60, especially if one of them has health problems that would make getting a separate life insurance policy difficult and expensive, it may be wise to retain second-to-die insurance.

People who want to pass on a family business still can make use of second-to-die for estate-equalization purposes. In other words, the death benefit can help them leave one child involved in the company in control, while providing funds to those children who don't want to work in the business, says Frederick Raffety, president of Rockford, Ill.-based Focus Financial Advisors Inc.

But for younger, affluent clients for whom saving for college may be a bigger priority, second-to-die insurance is going to be a less attractive investment. "For someone who is young and has a good life expectancy, it becomes an alternative investment, and you have to look at what your other alternatives are," Raffety says. "If the need for the insurance goes away, then you really have to consider what you want to leave your family. If insurance doesn't play a part in that situation, you're going to be more likely to cash it in and see what you can get to invest in things that will give you a greater return."