LIFE INSURANCE TRUST: Definition, Types & How to Set Up

You can safeguard your assets and the financial security of your loved ones by establishing a trust as part of your estate plan. Combined with other estate planning tools like wills and powers of attorney, they can be invaluable. Trusts can take several forms, but life insurance is commonly included. It might be complex to set up a Life Insurance Trust that’s why it is advisable to seek the advice of a lawyer before setting it up with any company. Read further to learn more about how to set up your Life Insurance Trust without any stress.

What Is a Life Insurance Trust?

The assets of an insurance trust are life insurance coverage. This type of trust is called an irrevocable trust. In the case of insurance trusts, the trust itself serves as both the policy’s owner and its beneficiary.

Through the establishment of a life insurance trust, a third party can manage the death benefit from a life insurance policy. The death benefit from your insurance will be given to your beneficiaries in accordance with your trust’s terms. The funds won’t have to go through probate, and your estate tax bill might go down as a result. Wealthy people and their parents, who want to plan how their children will receive life insurance benefits, sometimes use trusts.

How Life Insurance Trust Works

A life insurance policy can be placed in a trust known as an irrevocable life insurance trust (ILIT). This agreement is final and cannot be changed after it has been made. When a grantor includes a life insurance policy in an ILIT, they give up all control over the policy and its terms.

ILITs are better for the insured’s heirs than naming a single beneficiary to receive the death benefit of a life insurance policy. They offer legal and financial benefits such as lower tax liability, asset protection, and guarantees that the death benefit can only be used in ways that the deceased would have wanted. While both term and permanent life policies can be used to fund a life insurance trust, whole-life policies are more popular due to their guaranteed death payment. The coverage under a term policy may lapse, leaving the trust unpaid. It is similarly impossible to predict how much money will be in the trust because the value of a universal life policy can change over time.

Types of Life Insurance Trust

The following are the types of Life Insurance Trust:

#1. Irrevocable life insurance trusts (ILIT)

When you set up an irrevocable life insurance trust (ILIT), you can’t change your mind or get rid of it. This includes the cash value of a whole life policy and any other assets that are transferred to the trust. Despite these limitations, many wealthy people whose estates will be subject to federal estate taxes opt for irrevocable trusts. The federal estate tax does not apply to the policy’s proceeds if the trust, rather than the insured, is the policy’s owner. For this reason, the grantor can no longer use the cash value of a whole life policy for their own purposes, such as paying for retirement or other costs. While creating an irrevocable trust reduces your personal involvement with your assets, it may help wealthy individuals avoid estate taxes. That’s why many affluent people turn to Irrevocable Life Insurance Trusts (ILTS) for their long-term security and peace of mind.

Because life insurance payouts are often not distributed directly to minors, an ILIT may also be an efficient estate planning tool for people with young children. If you set up an ILIT, the trust will handle your children’s inheritance once you pass away. In contrast, a revocable trust may be preferable if you don’t need to distribute assets from your estate during your lifetime.

#2. Revocable life insurance trusts

Revocable life insurance trusts can be terminated or altered, as the name implies. Since it can be changed, this can allow you more leeway in how your assets are divided. The distribution of assets to minors, young adults, or those with special needs is often managed through revocable trusts. For those who worry about leaving a large quantity of money to a kid who is only 18, a trust can provide peace of mind by spreading out the distribution of the inheritance over many years. This strategy may reduce the risk that they will blow through their entire inheritance quickly.

The advantages of life insurance can also be used to support trusts, and while they are not required for formation, they can be helpful. Since trusts are not subject to probate, this permits other estate assets (such as a house or stocks) to be liquidated at a more convenient time, avoiding the delays and uncertainty associated with estate administration.

These trusts are helpful for parents who want to restrict their children’s spending on their inheritance. A trust can be set up to distribute the proceeds of your life insurance policy in payments over time so that your 16-year-old child does not receive the money all at once.

How to Set up a Life Insurance Trust

Have you been confused about how to set up your Life Insurance Trust? Worry not! Here is an easy guide on how to set up your Life Insurance Trust:

#1. Choose a Trustee

After a trust is established, its administration and implementation fall under the purview of the trustee. Choose a trustworthy individual who will follow your instructions exactly as written.

A trustee can be someone you trust, such as a member of your family, a trusted friend, an attorney, or anyone else you see fit. Whoever you choose, be sure you trust them to look out for your best interests and those of your beneficiaries.

#2. Choose your beneficiary(ies)

Those you designate as beneficiaries are the lucky recipients of your trust’s assets. It’s common practice to designate multiple beneficiaries, each of whom may get a different set of assets. Spouses, children, and other members of the immediate family are typical beneficiaries. The beneficiary you choose, however, is as open as the trustee you choose. Companies, nonprofits, social networks, and personal connections all count.

#3. Create a written trust agreement that is signed and notarized

Hiring a lawyer to draft your trust fund document is the most straightforward option. Doing so will guarantee that your trust complies with all applicable laws and regulations. If you would rather not work with a lawyer, you can find several forms at your local courtroom or on the website of your local government.

The following should be included in your trust fund paperwork:

The identity of your trust’s beneficiaries
What property do you want to put into the trust?
Exactly how you want your property divided up and used
Additional conditions, if any

When the trust fund document has been drafted to your satisfaction, it is time to sign it. Two witnesses must be present when you sign a trust document. Furthermore, your trust may need to be notarized in certain states. Even if notarization is not required by law in your state, it is a good idea to get your trust fund documents notarized anyway.

#4. Create a trust fund and deposit funds

After drafting and signing your trust paperwork, you may need to provide it to a financial institution before they open an account for you. The last step is to add money to your account. Deeds and titles to real estate and vehicles must be transferred, along with funds and securities such as stocks and bonds.

What Follows After Setting Up Your Life Insurance Trust?

You will no longer have authority over the assets you have designated for inclusion in the trust once they have been transferred to the trust account (unless you have appointed yourself as trustee). Instead, they will be held by your trustee until you decide to withdraw them. Your trust documents might specify whether the assets will be distributed simultaneously or at intervals.

What Is the Purpose of Life Insurance Trust?

There are two main purposes for creating an insurance trust. To begin with, the Grantor (the person who initiates the Trust) may be granted extensive power over the life insurance policy’s assets. But another major perk is that it can lessen the amount of money lost to taxation. The Grantor can use an Insurance Trust to get the most tax-free payout possible from a life insurance policy.

Benefits of Life Insurance Trust

The primary benefit of a Life Insurance Trust is that the Grantor can decide exactly what happens to the money after they pass away. The fact that an Insurance Trust is irrevocable may sound like a major drawback, yet it can really help bring order to chaos.

If a beneficiary is unable to handle receiving their inheritance upon the Grantor’s passing, for instance, the court can step in and oversee the distribution of the funds. The court has the discretion to reduce or prevent the distribution of funds to the intended beneficiary in light of the special circumstances. A Life Insurance Trust eliminates the need for the court to get involved by requiring the Trustee to distribute the proceeds to the beneficiaries in accordance with the terms set forth by the Grantor.

A Life Insurance Trust offers more than just this one perk. However, most of the benefits appear to revolve around enhancing one’s ability to exert authority and reducing the diluting effects on one’s estate.

There may be further advantages, such as:

Bringing down the value of estates that must pay taxes
Avoiding the inclusion of life insurance payouts in a surviving family member’s estate
Keeping out of the court system altogether
Providing access to funds more quickly than other options might be needed to pay estate taxes or other unforeseen costs.

Why Create a Life Insurce Trust?

The assets you leave in a trust fund will be managed in accordance with your instructions. You can specify who gets what and when in a will, giving you greater control over the distribution of your property, money, and other valuables.

The most important things in your life will be safe in trust funds until it’s time to share them. They also serve to shield property from the court-supervised probate procedure.

Is a Life Insurance Trust Right For Me?

A life insurance trust might not be essential for the average person. Having a significant net worth is often required to justify the effort and expense required to establish an irrevocable life insurance trust and get the associated tax benefits.

But a revocable trust might be a better choice if you have young children or a child with special needs. The trust can be used to provide long-term care for minors or children with special needs or to prevent young adults from blowing all their money at once. If the need for trust no longer exists as your family dynamic evolves, you can revise or terminate the agreement.

Should I Set Up a Trust to Hold My Life Insurance?

Putting life insurance into a trust is unnecessary for most people. This is due to the high formation costs associated with life insurance trusts as well as the potential for complex legal and tax consequences. They can also make estates more difficult to manage than they need to be. But if you have significant wealth that you wish to safeguard, a life insurance trust may be an important part of your estate strategy. It’s also a good option if you wish to give money to a minor or a youngster with special needs. You can get advice on whether or not to go this route from a financial expert or an attorney.

How Do You Use Life Insurance to Build Wealth?

If you go with a policyholder-owned mutual insurance firm, you may also be eligible for dividends that add to your cash value. PUAs, or paid-up additions, can be purchased with the payouts that whole-life policyholders get from their insurance company each year.

Can I Buy Life Insurance as an Investment?

Policies of life insurance that can be used as assets. To tailor your policy to your risk tolerance and objectives, you can decide how you want your investments diversified. As a result, permanent life insurance can protect you from fluctuations in the stock market.

Why Should You Not Put Life Insurance in a Trust?

Once an irrevocable trust has been established, it cannot be altered under normal circumstances. If you anticipate a future need to tap into the cash value of your life insurance policy, you may want to rethink placing it in an irrevocable life insurance trust. Although a revocable trust can be amended, doing so may incur expensive legal fees. This is why people with substantial wealth and well-defined estate planning goals utilize trusts rather than individuals whose financial circumstances are more fluid.

Final Thoughts

Life insurance trust establishment is more involved than drafting. Check out a good Life Insurance Trust company to work with. Also, instead of making a trust on your own, you should consult with a lawyer who focuses on this area of law. Your lawyer can assist you in establishing the trust and answering any queries you may have.

LIFE INSURANCE TRUST: Definition, Types & How to Set Up

What Is a Life Insurance Trust?

How Life Insurance Trust Works

Types of Life Insurance Trust