How to Set Up a Life Insurance Trust

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A woman watching her young child and spouse on the beach.
A woman watching her young child and spouse on the beach. (Image: dblight/iStock/Getty Images)

A life insurance trust avoids or minimizes estate taxes. Turning your life insurance policy over to an irrevocable trust, a requirement of a life insurance trust, makes sure your beneficiaries receive the full payout from your policy instead of losing some of those benefits to estate taxes. You give up ownership of the trust when you create an irrevocable trust, which makes the trust separate from you. So the Internal Revenue Service does not consider it part of your taxable estate.

Estate Considerations

An irrevocable trust cannot be changed or revoked like a revocable trust, which a creator controls and can alter at any time. Advantages of a life insurance trust, also called an irrevocable life insurance trust or ILIT, also include protection from creditors following your death. Since you don’t own the trust, the assets cannot be used to collect debts. Life insurance trusts benefit people with sizable estates, because the federal estate tax exemption rate was $5.34 million as of 2014. However, some states also have estate and inheritance taxes, so your estate, including your life insurance policy, may still benefit from a life insurance trust, depending on your assets and state’s laws.

Professional Advice

Talk to a financial adviser to determine your net worth and an insurance agent about what type of life policy works best for an irrevocable trust for your particular financial situation. Then discuss setting up the trust with an estate-planning attorney. The attorney will be familiar with the tax laws in your state that affect your estate. Explain your goals for establishing the trust and how you want to have assets disbursed after your death. The attorney is necessary for essential legal advice and to properly prepare the draft of the trust document, which determines the funding and distributions of the trust.

Conditions and Beneficiaries

It’s entirely up to you to establish the conditions for the trust and the beneficiaries you select. Beneficiaries usually include a spouse, children or grandchildren, but you, of course, can leave your estate to anyone you decide. Conditions might include the monthly or annual distributions from the trust or making sure children receive benefits at a specific age. You could also stipulate milestones that determine distributions, such as when your child graduates from college, gets married or buys a home. Consider your conditions permanent, because you would have to go through time-consuming and expensive changes to create a new trust if you change your mind.

Trustee

You then select a trustee to manage the trust. You cannot be a trustee because it would connect you to the trust, which would no longer be considered irrevocable by the IRS. A trustee can be someone you feel close to and knows your family situation, a financial adviser knowledgeable about trusts or even a financial institution. The trustee handles premiums you pay into the trust to keep the policy in force, manages administrative duties of the trust and takes care of distributions, according to the trust’s directions, following your death.

Buying the Policy

Select a life insurance policy after the trust has been set up and all directions of the trust document are in order, FindLaw notes. You buy a policy the same way as a normal life insurance policy, but the owner of the policy is the trust. The trust must be in effect at least three years before your death, according to the IRS, to prevent quick transfers into a life insurance trust to avoid estate taxes because of an anticipated death.

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