Life Insurance Trust

The main purpose of setting up a life insurance trust is to have a designated owner for the life insurance policy. In cases where the insured person is the owner of the policy, the proceeds are subjected to estate tax when he or she dies.  Why is there such a concern regarding estate taxes?  This is because the current rate is 45%, that’s why.  Beneficiaries could stand to lose thousands of dollars in estate taxes and since times are tough, many dependents would rather use the cash for their own family’s needs.

This is not the case when there is a life insurance trust that is set up.  All the proceeds are to be exempted from both estate and income taxes.  However, getting a life insurance trust should be done with caution because there are also disadvantages in this type of set up.

The insured party will no longer have the right to change the beneficiary since the trust itself, is equivalent to the receiving party. The insured person cannot act as the trustee of his own life insurance policy, as aforementioned due to estate tax. Only the designated trustee, who is another individual or party, has the right to designate trust beneficiaries.  This designation is permanent once the trust has been created.  It does not leave room for any flexibility should family circumstances change.

Another prohibition is for the insured person to be able to borrow against the policy. If the policy is not under a trust, most insurance providers allow the owners to loan an amount from their policies.  However, upon creation of the trust the insured person no longer owns the policy.  Thus, the insured person has right to take a loan on it.

Before the policy gets exempted from estate tax, the transfer of ownership must take place at least three years prior the death of the insured party.

This is the government’s requirement in order for the trust to be recognized.  If the insured party does survive for three years, the cash value of the insurance policy has grown with interest and can have a gift tax that is a collectible amount by the government.  The best scenario is for the trust to apply for a new policy on the insured person’s life.  Although he or she will not be able to own it, there won’t be a cash value build up, in turn, no taxable gift will be made.

Trusts are irrevocable.  Once they are created, the policy cannot be returned to the original policy holder who is the insured party. A lot of banks and trust companies offer low fees if one would be interested in hiring them as insurance trustees because there are essentially no risks involved.

Despite the seemingly troublesome nature of an insurance trust, many people consider it to be worth all the hassle and cost.  These citizens believe that their life insurances policies are great assets to leave behind to their loved ones, especially if the full amount of the death benefit could be taken advantaged of.