What is a Life Insurance Trust and Why Consider it?

Life Trust and Estate Planning

Not amendable or revocable, each life insurance trust is the beneficiary and owner of at least one life insurance policy. When the person listed on the life insurance policies dies, the Trustee is required to invest all proceeds from the insurance policies and administer the trust for the beneficiaries. A married person’s children and spouse are usually the beneficiaries of their trust. If survivorship insurance that only pays out upon the death of both spouses is owned by the trust, the couple’s children are the likely beneficiaries, however the trust owner can name whomever they choose.

Tax Benefits

One reason that citizens of the United States may benefit from a life insurance trust is because insurance policies that are paid directly may be subject to estate tax, while federal estate tax doesn’t have to be paid if the trust is the policy owner. It is a good idea for people with life insurance policies to transfer their policies to a life insurance trust as soon as possible, because the transfer will only be recognized by the Internal Revenue Service only if the insured person lives for at least three years after the transfer is complete.

Freedom From Creditors

Another benefit is that a life insurance trust that is irrevocable provides liquidity to pay final expenses without having to sell the insured’s assets. Parents who have a life insurance trust that is irrevocable can have a spendthrift provision included in their trust document, which grants discretion in giving insurance distributions to the beneficiaries to the trustee. This means that any amount of money given to the insured’s beneficiaries from the trustee cannot be accessed by the beneficiary’s creditors.

Each insurance trust may either be funded or non-funded. A life insurance trust that is funded must be the owner of both assets that produce income and life insurance contracts. The income produced by the assets generally pays at least part of the insurance policy premiums. There are two reasons that insurance trusts that are funded are not normally used. One of them is that the person transferring assets that produce income to the trust is required to pay gift tax. The other reason is that the grantor is required to pay tax on the income generated by the trust.

Insurance trusts that are unfunded are more common that funded insurance trusts because they are less complicated. Insurance trusts that are unfunded own at least one insurance policy. These life insurance trusts are normally funded by the grantor who transfers the premium amounts as annual gifts.

How Much Control Does the Trustee Have?

The trustee of each insurance trust has the authority to loan the proceeds of each policy to the insured person’s estate or purchase assets from the estate. The trustee is not required to perform either of these actions. The trustee has complete control over every insurance policy owned by the trust. The insured can have control over the distribution of their insurance trust by leaving specific instructions for the trustee. The trustee may be given directions to withhold distribution of the funds until the beneficiaries reach a certain age or demonstrate a certain positive behavior.