Can a Trust Be a Life Insurance Beneficiary?
Most U.S. jurisdictions allow life insurance trusts, in which a trust is designated as the beneficiary of the life insurance proceeds. However, the settlor (the individual assigning the life insurance proceeds to the trust) must be mindful of other laws that may impact distribution of life insurance proceeds, and should seek legal counsel in constructing the trust.
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Life Insurance Trust
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An life insurance trust is one in which the life insurance policy is given to the trust, and proceeds of the policy become the property of the trust. While trust law requires that all trusts have a res (actual, designated property that will form the principal of the trust), most states' statutes have recognized a beneficiary's contingent right to receive the proceeds of a life insurance policy as a sufficiently defined res to justify the existence of the trust. The fact that the proceeds of the policy are not defined or available at the moment of trust execution does not affect the trust's validity. Life insurance trusts are irrevocable, and the gift of the policy to the trust must generally be made at least three years before the death of the policy holder.
Other Types
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A life insurance policy may also be part of an otherwise funded trust. Proceeds from a life insurance policy may acceptably be grouped with other designated assets as the trust res. Rather than explicitly designating the trustee as the beneficiary of the life insurance proceeds, a settlor may also designate the trustee as the recipient of the proceeds in a will (this structure is known as a testamentary trust). A life insurance contract is considered non-probate property, so the proceeds of the policy won't be subject to probate despite being devised in the will.
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Mechanics of Trust
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In the usual trust, the trustee (the individual administering and investing on behalf of the trust) holds legal title to the assets; such legal title may or may not include discretion over making distributions of the trust. The trust beneficiary (the individual or organization receving the benefits of the trust) will hold equitable title, which entitles him to distributions but gives him no effective control over the trust. The usual method of channeling life insurance proceeds into a trust is to designate the trustee as the beneficiary of the life insurance policy, thus transferring legal ownership to the trust.
Characterization of Proceeds
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A settlor living in a certain type of property jurisdiction may not be entitled to designate all life insurance proceeds for trust. Courts in community property states will often divide the proceeds of life insurance policies based on how much of the policy's premiums were paid from the community (husband and wife's assets) and how much from the separate property of one of the spouses. A few states will also grant the entire proceeds of the policy to the estate of the person who made the last premium payment.
Advantages
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There are advantages to funding a trust with life insurance proceeds. The settlor's creditors generally cannot reach life insurance benefits that will be paid into a trust for the benefit of the settlor's spouse or child. Many states mandate that shares of nonprobate property must be paid to spouses and children; however, life insurance proceeds generally are not subject to these "elective share" statutes. For some settlors, there may also be estate tax benefits to receiving life insurance proceeds in trust.
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- Photo Credit signing a contract image by William Berry from Fotolia.com
