What Is A Life Insurance Trust?

What Is an Irrevocable Life Insurance Trust?

One helpful estate planning tool is an irrevocable life insurance trust, which offers several benefits, such as protecting beneficiaries from paying estate taxes. Learning about these trusts can help individuals make informed decisions regarding their estate plans. Read about what a life insurance trust is and find out how a seasoned California estate planning attorney from Von Rock Law can be of assistance by calling (866) 720-0195.

How Trusts Work

According to the Internal Revenue Service (IRS), trusts generally refer to arrangements whereby a legal entity known as a trust holds the legal title to a piece of property or collection of assets, originally owned by the person establishing the trust, who is referred to as the grantor or settlor. Because a trust is not a person, the trustor designates another individual or entity in the trust documents to be the trustee. The trustee will oversee the trust and use or maintain the assets it contains for the benefit of at least one beneficiary, who is also designated in the trust document.

Understanding Insurance Trusts

The American Bar Association (ABA) defines insurance trusts as trusts aimed at holding life insurance policies. There are two main types of insurance trusts, revocable and irrevocable, which vary in the degree of flexibility and control offered.

Here is more information concerning these types of trust:

  • Revocable: These trusts enable the settlor to alter or end them whenever they wish, providing flexibility concerning asset division and distribution. This can be an effective option for those who are uncertain about what to distribute to their beneficiaries, and who they want their beneficiaries to be.
  • Irrevocable: Once a trust of this kind has been established, the settlor cannot alter or cancel its terms. This means the grantor loses control of the insurance policy proceeds, but it also allows the settlor to reduce or even remove any tax burdens potentially taken on by the beneficiary. Individuals often opt for these trusts because they help minimize estate taxes, eliminate gift taxes, preserve eligibility for government benefits, protect assets from creditors, and plan inheritances for future generations.

What Is the Purpose of a Life Insurance Trust?

Beneficiaries of life insurance policies receive these funds after the policyholder dies, without paying income tax on the proceeds, but such payouts often accrue estate tax. If a married individual names their spouse as the policy’s beneficiary, the surviving spouse does not pay estate tax due to the proceeds qualifying for a marital estate tax deduction. However, this does not apply to unmarried partners or to the beneficiaries of the widowed spouse when they, too, pass away.

Insurance trusts remove insurance policy proceeds from a person’s estate, thereby preventing the estate’s value from exceeding the exemption threshold for paying estate tax. Therefore, the primary purpose of using an insurance trust is to help beneficiaries avoid paying estate taxes at the federal and state levels.

What Is a Trust in a Life Insurance Policy?

Life insurance trusts occur when a person transfers the legal title of either a term or whole-life policy to the trust. When this happens, the trust legally owns the policy, while the appointed trustee manages the policy’s benefits. Upon the insured individual’s death, the trust receives the policy’s death benefit. The trustee then distributes this money in accordance with the trust’s terms, set out by the grantor in the trust document to dictate to whom to distribute the funds and when, such as when the beneficiary reaches a certain age or completes a specific life event, like getting married or graduating from college.

Many individuals opt to create these trusts for whole-life policies, which provide the beneficiary with an assured death benefit, instead of term policies, which provide cover for a limited period. One of the main reasons behind this is what could happen if the term finishes before the insured individual passes away. In this scenario, the trust might not have adequate funds to transfer to the beneficiaries, resulting in financial vulnerability for these people.

What Is the Difference Between a Trust and a Life Insurance Policy?

Trusts are legal arrangements involving the maintenance of assets, such as cash, shares, property, and land, managed by one or more people to the of benefit other individuals or entities. Settlors establish trusts for numerous reasons, including controlling and protecting family assets, managing a young person’s affairs until they come of age, handling an incapacitated person’s affairs, and transferring assets to loved ones within the settlor’s lifetime.

In contrast, a life insurance policy refers to a legal agreement between the policyholder and insurer, whereby the insurance company promises to pay the named beneficiary a specific amount of money when the insured individual dies. Some life insurance policies may also pay out the proceeds during certain events, like terminal illness, and might cover other expenses, including funeral costs. For these policies to remain valid, the policyholder needs to pay frequent premiums, although some policies might involve paying a large one-off sum instead.

Who Is the Beneficiary of a Life Insurance Trust?

The beneficiary of an insurance trust is a named entity or individual who stands to inherit the proceeds of a life insurance policy after the policyholder dies. Worth noting is that the beneficiary only inherits these funds on the condition of a successful insurance claim during the policy’s lifetime. The policyholder can name a single beneficiary or a group, and examples of named beneficiaries include:

  • Spouses
  • Partners
  • Children or stepchildren
  • Siblings
  • Parents
  • Other relatives
  • Friends
  • Charities

Understand more about a life insurance trust and discover how a San Francisco estate planning attorney can help individuals create effective estate plans by arranging a consultation with Von Rock Law.

What Is a Major Problem With Naming a Trust as the Beneficiary of a Life Insurance Policy?

In answer to “What happens when a trust is the beneficiary of a life insurance policy?” the proceeds paid are subject to estate tax because the law does not consider trusts to be individuals. In addition, insurance policy proceeds paid to trusts are unlikely to qualify for state inheritance tax exemptions, leading to higher taxes owed than in some other financial arrangements.

Contact a California Estate Planning Attorney Today

Trusts have numerous structures, some of which involve life insurance policies. When used together with other important estate planning documents, they can help individuals protect their assets and provide financial security to their loved ones. Learn more about a life insurance trust and explore how a San Francisco estate planning attorney can aid individuals with their estate planning concerns by contacting Von Rock Law at (866) 720-0195.

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