Can an Insurance Policy Fund a Living Trust?
A living trust is a legal arrangement that allows you to transfer certain assets to the control of another individual during your lifetime. This individual, known as a trustee, is responsible for managing those assets according to your wishes. You may transfer several types of assets to a trust, including your life insurance policy. By creating a life insurance trust, you can potentially provide taxation benefits to your heirs.
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Function
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The primary function of a life insurance trust is to eliminate any estate taxes your beneficiaries have to pay on life insurance proceeds after your death. Rather than naming your spouse, children or other heirs as beneficiaries of the policy, you transfer it to the control of the trust. In doing so, you are no longer considered an owner of the policy, meaning it cannot be included in your estate. Upon your death, the proceeds of the life insurance policy are paid to the trust and your trustee assumes responsibility for distributing the funds to your heirs accordingly.
Establishing a Life Insurance Trust
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A qualified estate planning attorney can guide you through the process for creating a life insurance trust. There are essentially two steps, the first of which involves creating the trust on paper. Generally, you must draft a declaration of trust or trust agreement, which names yourself as the grantor or settlor, identifies the individual or individuals who will serve as trustee and lists your beneficiaries. You can then transfer an existing life insurance policy into the trust or have the trustee apply for a new policy. You may choose to fund the trust with a whole-life policy, term-life or universal-life policy, depending on your needs. Once the trust owns the policy, the trustee is responsible for paying the premiums.
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Life Insurance Trust Benefits
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A life insurance trust offers several benefits to your heirs in addition to the elimination of estate taxes. Holding the policy in trust allows your beneficiaries to bypass the probate process, which means they avoid paying probate and court costs and have access to the money much more quickly. An insurance trust also gives your heirs greater privacy, since trust assets do not become part of the public record. Transferring your life insurance trust also helps you avoid conservatorship if the policy's beneficiary is incapacitated at the time of your death. The trustee can continue to manage the trust assets without court intervention.
Considerations
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Life insurance trusts are irrevocable, meaning they cannot be canceled or altered once they are created. This means that if at some point you wish to increase or decrease the amount of the policy or exclude one or more beneficiaries, you would be unable to do so. If you transfer an existing policy to a life insurance trust, it could still be counted as part of your estate. If you die within three years of transferring the policy, the IRS requires your beneficiaries to pay estate taxes on the proceeds.
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References
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