Do I Need a Life Insurance Trust?
Life insurance is typically an important part of anyone’s financial plan, because it helps to provide a death benefit in the event that you pass away while the policy is active. Many people use life insurance policies to help pay off a mortgage, finance college education for children, and replace income from the deceased family member. An irrevocable life insurance trust is one way to structure your policy.
In a life insurance trust, when the insured passes away, the trustee will take the proceeds from the life insurance policy and invest them. The underlying goal of this process is to make sure that the death benefit payout is free from federal taxation. In a typical life insurance policy without a trust, the proceeds are transferred from the insurance carrier to the beneficiary. This could, in turn, affect the estate size and estate taxes of the beneficiaries that receive the proceeds.
Another reason that many people consider a life insurance trust is to protect their beneficiaries from themselves. For example, a mother of a financially irresponsible child may not want that child to receive a lump sum death benefit. When children are not financially prepared to handle a lump-sum payout, they may spend through the death benefit quickly and end up in financial ruin. An irrevocable life insurance trust gives the grantor some power and control over way in which the assets are distributed.
Choosing a trustee for your life insurance trust is an important decision, since this person must have some financial understanding of what to do with that death benefit when it pays out from the insurance carrier. Assigning an effective trustee can give you the comfort that the proceeds from the policy will be managed appropriately.
When an irrevocable life insurance trust is put into place, it pulls the life policy out of the estate. It can be used to cover payment of estate costs, to provide cash assets to the beneficiaries named in the trust, and protects the proceeds from being included in the taxable estate. Since you are essentially handing over the control to the trust, you cannot change the beneficiaries on the policy or borrow against the policy.
Irrevocable life insurance trusts can be complex, but they are also a valuable solution when you want to protect the life insurance proceeds from an estate. Speak with a professional to get guidance about how to set one up.