How Does a Life Insurance Trust Work?

An agreement where the owner of the policy as well as the beneficiary create a trust having the nature of being irrevocable and non-amenable, is known as a life insurance trust. The agreeing parties can have a trust for one or several life insurance plans. When the insured person dies, the designated “Trustee” is responsible for investing the proceeds of the claim. He or she also oversees the trust for the beneficiaries. Often, when the trust owns coverage for someone who is married, the spouse and children, who are not insured, are the beneficiaries. Some trusts will only allow payouts when both spouses have died. This is called survivorship insurance and, in which case, only the child or children become the beneficiary of an insurance trust.

Ownership of life insurance policies must be planned carefully, if one intends to avoid payment of estate taxes in the United States. In cases where the owner of the insurance policy is the insured person, then the proceeds are subject to this form of tax. Some insured parties would rather name a child or spouse to be the owner of the insurance, so that the beneficiary would be free from the burden of taxation. However, there can be disadvantages in doing so.

When the beneficiary is a minor or if one does not have enough knowledge in investing wisely, providing him or her with a lump sum right away might not be in the best interest of that person, even the deceased. In terms of estate tax payment, at first it may seem like it is a lot of money to lose. On the other hand, the beneficiary will not have to worry about selling assets in order to pay off the insured person’s debts or taxes. Either way, the beneficiary’s assets will still gain from the proceeds given that funds for taxes and other payables are readily available. No other assets need to be sold in order to raise money for payment.

The best option would be to establish an irrevocable trust for your life insurance policy. Ideally, the trustee must be the original policy owner. The owner, then, has to transfer the insurance policy to an irrevocable insurance trust. It is a must to accomplish everything three years prior to the death of the insured individual in order for the IRS to recognize the insurance trust. Otherwise, this will not be effective and the proceeds go straight to the asset pool where federal estate taxes shall be applied.

Two categories separating insurance trusts are the funded and non-funded ones. If the trust owns more than one insurance policy and other financial assets that produce income, it is categorized as a funded insurance trust. It would be possible to use the income from the said assets for payment on premiums. However, this type of trust is not commonly used due to gift taxes that can be levied on some assets. Normally, the trustee is authorized to get assets and even take a loan on the insurance proceeds for his or her personal use. The trustee basically has all rights to ownership of the policy and the insurance proceeds are exempt from estate taxes of the deceased party.