A person may create a life insurance trust in order to have more control over their insurance policies and how the proceeds are paid out to their named beneficiaries. Trusts can also help to reduce or even eliminate estate taxes so that more of your assets are passed onto your heirs. But what is a life insurance trust comprised of and how does it work?
Trusts can be filled with a lot of confusing language, especially when you're just getting started. However, when you break down a trust it's essentially made up of three main components:
- The grantor:
As the creator of the trust, you are considered the grantor. - The trustee:
A trustee makes decisions according to your wishes and that are in your best interest. As the grantor, you get to select a trustee who will manage your trust. - The trust beneficiary(s):
The beneficiary is an individual, institution, trustee, or estate which receives, or may become eligible to receive, benefits under a will, insurance policy, retirement plan, annuity, trust, or other contract.1 Simply put, naming a beneficiary in your will or as part of a trust, ensures that your assets will go where you want them to when you die.
How a life insurance trust works
The insurance trust owns your life insurance policy. The trust holds the insurance policy with you as the named insured and when you die, the insurance benefit is paid to the trust. At that point, the trustee collects the funds and pays any estate taxes and/or other expenses (such as debts, legal fees, and income taxes that may be due on IRAs and other retirement savings benefits), and then distributes money to the trust's beneficiaries as you per your instructions.
The benefits of a life insurance trust
Naming your trust as the beneficiary of your life insurance policy can give you more control over how the proceeds are distributed. For example, if you name your spouse or partner as the beneficiary of your life policy and he/she is incapacitated at the time of your death, the court may take control of the money and insist on court supervision. However, if your trust is the beneficiary of the policy, the trustee can use the proceeds to provide for your spouse or partner directly, without any court interference.
Other benefits can include:
- Providing immediate cash to pay estate taxes and other expenses
- Helping to reduce estate taxes by excluding life insurance proceeds from your estate
- Avoiding delays and legal fees associated with probate
- Proceeds are received free from income and estate taxes
- Puts you in control over the insurance policy and how proceeds are used after you're gone
- Can provide income to spouse without insurance proceeds being included in spouse's estate
For more information on life insurance, trusts, and estate planning, visit the Protective Learning Center.
1. http://www.investorwords.com/460/beneficiary.html
