What Is A Life Insurance Trust?

What Is A Life Insurance Trust - How To Set Up A Life Insurance Trust - Benefits Of A Life Insurance Trust - Disadvantages Of Putting Life Insurance In Trust

What is a life insurance trust? 

In this article, you’ll learn about: 

  • what a LIT is and how they work
  • putting life insurance into a trust
  • types of life insurance trusts
  • how to set up a life insurance trust
  • benefits and disadvantages of LITs

Let’s dig in. 

Table of Contents

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What Is A Life Insurance Trust?

A Life Insurance Trust is a legal tool. 

You create it to own your life insurance policy

This way, the policy doesn’t belong to you personally. 

Instead, the trust owns and controls it. 

A trustee manages the trust. 

You choose this person. 

When you pass away, the insurance pays out. 

The trust gets the money. 

Your trustee makes sure your loved ones receive it, based on the rules you set. 

This setup can reduce estate taxes

It can also give you more control over how your family uses the insurance money.

Read More: Distribution Of Irrevocable Trust Assets To Beneficiaries

How A Life Insurance Trust Works

A Life Insurance Trust is a legal tool you create to hold a life insurance policy. 

You pick a trustee to manage it. 

The trustee buys a life insurance policy on your life, using the money you put into the trust. 

This way, the trust owns the policy, not you. 

When you die, the insurance company pays the policy amount to the trust. 

The trustee then gives this money to the people you chose as beneficiaries. 

By using a Life Insurance Trust, you can keep the insurance payout from getting taxed as part of your estate. 

This means more money for your loved ones. 

It’s also a smart way to control when and how they receive the funds.

Read More: Who Owns The Property In An Irrevocable Trust

Why Put Life Insurance In A Trust

Putting life insurance in a trust helps avoid estate taxes. 

When you use a trust, the insurance payout doesn’t count as part of your estate. 

This means more money for your heirs. 

A trust also gives you control over how the money is used. 

You can set rules for when and how your beneficiaries get the funds. 

For example, you might want them to reach a certain age first. 

A trust can also protect the insurance payout from creditors. 

If someone sues your estate, they can’t touch the money in the trust. 

In short, a life insurance trust can:

  • save on taxes
  • protect assets
  • give you control over your legacy

Read More: How Much Money Can You Inherit Without Paying Taxes On It?

Life Insurance Trust vs Life Insurance

A Life Insurance Trust is a legal entity that owns a life insurance policy. 

When you use a Life Insurance Trust, you put your policy into the trust, and it manages the policy for you. 

This setup can help reduce estate taxes because the policy isn’t part of your estate. 

It also gives you control over how the death benefit gets distributed to your beneficiaries.

On the other hand, with Life Insurance alone, you own the policy directly. 

When you die, the death benefit is part of your estate, which could mean higher estate taxes. 

The money usually goes straight to your beneficiaries without the controls a trust offers.

In summary, a Life Insurance Trust can offer tax benefits and more control over the death benefit.

But owning Life Insurance directly is simpler but might have tax implications and less control.

Read More: Am I Entitled To My Husband’s Property If He Dies And My Name Isn’t On The Deed?

Life Insurance Trust Example

A Life Insurance Trust is a legal tool that holds and manages a life insurance policy. 

For example, let’s say Jane wants to make sure her kids:

  • can pay estate taxes 
  • have financial support after she’s gone 

She creates a Life Insurance Trust and moves her life insurance policy into it. 

Jane names her brother, Paul, as the trustee, responsible for managing the trust. 

After Jane passes away, the trust receives the insurance payout. 

Paul, as the trustee, makes sure that the money is used to pay estate taxes.

And then distributes the rest to Jane’s kids according to the rules Jane set up in the trust. 

This way, Jane ensures her kids are taken care of and reduces the estate taxes they might face.

Types of Life Insurance Trusts

Let’s look at the types of life insurance trusts that you can buy: 

  • revocable life insurance trusts
  • irrevocable life insurance trusts
  • life insurance trusts for children

Revocable LITs

A Revocable Life Insurance Trust is a trust you can change or cancel. 

You put a life insurance policy in it. 

This means the trust owns the policy, not you. 

“Revocable” means you can make changes. 

You can take the policy back, pick a new trustee, or change the beneficiaries. 

This flexibility lets you adapt to life changes. 

But, since you control it, the assets may still count in your estate. 

This can affect estate taxes. 

It’s good for keeping options open but doesn’t give all the tax perks of an irrevocable trust.

Read More: Does A Revocable Trust Become Irrevocable Upon Death

Irrevocable LITs

The Irrevocable Life Insurance Trust, often abbreviated as ILIT, is a type of trust that you can’t change or take back once you set it up. 

The word ‘irrevocable’ means that it’s permanent. 

When you place a life insurance policy inside this trust, it’s no longer yours. 

The trust owns it. 

The money paid from the insurance when you die doesn’t count as part of your estate. 

This is because you don’t own the policy anymore.

This can save on estate taxes. 

The ‘revocable’ part refers to a different type of trust, where you can make changes or get your property back. 

But ILIT is not revocable. 

It’s set in stone. 

This can be good for taxes, but make sure it’s what you want before you set one up.

Read More: What Happens To An Irrevocable Trust When The Grantor Dies?

Life Insurance Trust For Children

A Life Insurance Trust for children is a legal tool that parents use to set aside life insurance benefits for their kids. 

Parents create the trust and put a life insurance policy inside it. 

They pick someone reliable to manage it, known as a trustee. 

The trustee uses the insurance money to take care of the children if the parents pass away. 

The trust ensures that the insurance money isn’t wasted or spent too soon. 

It can also keep the insurance benefits from being taxed. 

When the children reach a certain age or meet specific conditions, they can receive the money directly. 

This type of trust is a way for parents to secure their children’s financial future.

How To Set Up A Life Insurance Trust

Here are the steps to set up a life insurance trust:

  1. Choose the type of trust: Decide between an Irrevocable Life Insurance Trust (ILIT), which you can’t change, and a Revocable Life Insurance Trust, which you can alter. Most people choose ILIT to avoid estate taxes.
  2. Pick a trustee: Select someone trustworthy to manage the trust. This person will handle the insurance policy and distribute funds when needed.
  3. Create the trust document: Work with a family trust attorney to draft the trust document. This paper lays out all the rules of the trust.
  4. Place an insurance policy in the trust: Either buy a new life insurance policy with the trust as the owner or transfer an existing policy into the trust.
  5. Notify the insurance company: Inform the insurance company of the trust, and make sure the policy names the trust as the owner and beneficiary.
  6. Fund the trust: Transfer money into the trust so it can pay the insurance premiums.
  7. File gift tax returns if necessary: If you transfer money to the trust to pay premiums, you might need to file gift tax returns.
  8. Inform beneficiaries: Let the trust beneficiaries know about their interests in the trust.

Remember, setting up a Life Insurance Trust is a legal process.

So working with a trust attorney experienced in estate planning is crucial for getting it right.

Read More: Do I Need A Trust To Avoid Probate

Transferring Life Insurance Policy To Trust

To transfer a life insurance policy to a trust, you first create a trust document

This specifies how the trust will be managed. 

Then, you change the owner of the policy to the trust. 

You do this by contacting your insurance company and filling out a change of ownership form. 

Make sure the trust is the new policy owner. 

Next, you may also need to change the beneficiary of the policy to the trust. 

Again, contact your insurance company and complete the necessary forms. 

Keep in mind that if your trust is irrevocable, you can’t change it back. 

This move can have tax benefits and help protect your assets. 

However, it’s important to think through and understand all the implications before making the transfer. 

It’s also a good idea to work with an attorney or financial advisor who specializes in estate planning. 

They can help ensure that the transfer:

  • aligns with your goals 
  • complies with the law

Read More: How To Put House In Trust With Mortgage

Transfer For Value Rules

Transfer for Value Rules apply to life insurance policies. 

These rules say that if you sell or transfer your life insurance policy to someone else for something in return, the policy’s death benefits may be subject to taxes. 

Normally, life insurance payouts are tax-free. 

But, if the policy is transferred in exchange for money or other benefits, the tax-free perk might be lost. 

There are exceptions. 

The rules don’t apply if you transfer the policy to:

  • the insured person
  • a partner of the insured
  • a partnership where the insured is a partner
  • a corporation where the insured is a shareholder or officer

Being aware of these rules is important for smart financial planning.

Read More: Who Needs A Trust Instead Of A Will?

Life Insurance In Trust Pros And Cons

Let’s look at some benefits and disadvantages of having a life insurance trust. 

Benefits Of A Life Insurance Trust

A Life Insurance Trust offers tax benefits. 

By removing the policy from your estate, it can reduce estate taxes. 

It lets you control how your beneficiaries use the funds. 

You can set rules on when they receive the money. 

The trust can protect the insurance proceeds from creditors. 

This ensures your beneficiaries get what you intend for them. 

It can also be useful in special situations like providing for a special needs dependent. 

The trust shields the proceeds from being counted as assets, which might disqualify them from government assistance.

Read More: Does Your House Have To Be Paid Off To Put It In A Trust

Disadvantages Of Putting Life Insurance In Trust

When you put life insurance in a trust, you lose control. 

This means you can’t change beneficiaries or terms without a hassle. 

Setting up the trust costs money, as you need legal documents. 

Annual maintenance fees can add up. 

Trusts can be complex, and errors can cause tax issues. 

If you transfer an existing policy, there’s a three-year look-back period. 

If you pass away within those three years, the policy might still count towards estate taxes. 

Choosing a trustee is critical; a poor choice can mismanage the trust. 

The trust needs separate tax filings, which takes time and effort. 

Lastly, if laws change, the trust may not offer the same benefits.

FAQs About Life Insurance Trusts

Here are some common questions our clients ask us about Life Insurance Trusts. 

Should A Life Insurance Policy Be In A Trust?

Yes, placing a life insurance policy in a trust can be beneficial. 

When you put your policy in a trust, it won’t be part of your estate. 

This means your loved ones could avoid estate taxes on the payout. 

A trust also gives you more control over how the insurance money is used. 

For example, you can set rules on when your beneficiaries receive the funds. 

This can protect them from spending the money too quickly. 

It’s important to think about your goals and talk to an expert to set up the trust correctly.

Read More: What Happens If A Beneficiary Does Not Claim Their Inheritance?

What Is A Major Problem With Naming A Trust As The Beneficiary Of A Life Insurance Policy?

One major problem with naming a trust as the beneficiary of a life insurance policy is the lack of flexibility. 

Once you name a trust as the beneficiary, you set strict rules on how the policy’s proceeds get distributed. 

This means that if circumstances change, like family needs or financial situations, adjusting these rules can be difficult or impossible. 

Additionally, setting up a trust involves legal fees and administrative tasks, which can make the process expensive and time-consuming. 

Naming a trust requires careful planning to ensure it meets your long-term goals and accommodates any future changes.

Read More: How Long Can You Keep An Estate Open After Death

Is Life Insurance Part Of An Estate After Death?

Yes, life insurance can be part of an estate after death. 

If a person names their estate as the beneficiary of the life insurance policy, the proceeds go into the estate. 

If the person names specific individuals as beneficiaries, the money goes directly to them, bypassing the estate. 

It’s important to choose beneficiaries wisely to avoid estate taxes and probate delays. Naming the estate as the beneficiary might also affect creditors’ claims. 

Selecting individuals keeps the money separate from the estate, typically making it tax-free and quickly accessible.

Read More: What Are My Rights If My Name Is Not On A Deed But Married

Set Up A Life Insurance Trust

If you want help from a trust law firm, fill out the form below. 

At The Hive Law, we understand the importance of:

  • protecting your hard-earned assets 
  • ensuring your family’s future
  • not losing everything to creditors and lawsuits
  • properly (and legally) distributing assets 

We only accommodate a limited number of clients each month.

So don’t miss your opportunity to work with our trust fund lawyers.

Benefits of our trust services:

  • Tailored solutions to fit your unique needs and goals
  • Expert guidance in navigating complex tax and legal matters
  • Preservation of your wealth for future generations
  • Streamlined asset distribution according to your wishes

Avoid the pitfalls of inadequate estate planning strategies:

  • Creditors seizing your assets
  • Lawsuits jeopardizing your family’s financial security
  • Family disputes over inheritance
  • Costly and time-consuming probate processes

Talk soon.

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