A life insurance trust provides a way for insured individuals to combine the benefits of a trust and the proceeds from a life insurance policy. By placing a life insurance policy under a trust, beneficiaries will not have to pay estate taxes on the life insurance death benefit which can sometimes be millions of dollars for certain policies. This is because the trust becomes the legal owner of the life insurance policy and therefore is not subject to estate taxes. For those individuals carrying large life insurance policies it makes sense to create a life insurance trust so grieving loved ones who are counting on life insurance benefits don't have to deal with the resulting tax issues. Professional legal assistance will most likely be necessary to create a life insurance trust and to evaluate the advantages and disadvantages.
In order for a life insurance policy to be placed into a trust there must be a third-party trustee which can handle administration of the trust in the event of the insured individuals death. It is common practice for assets such as homes and investments to be placed in a trust and a life insurance policy is no different. The trustee must be a designated third-party such as a bank or trust management company and not the individual with the life insurance policy. Otherwise, when the insured dies, trust or not, the proceeds would be taxed under estate tax law. There is an annual fee charged by the trustee for administration of the trust and they will handle all services until the beneficiaries are of age. The legal age for most beneficiaries to access funds in a trust is 21 but in some circumstances it can be as low as 18 years of age. The most common beneficiaries of a trust are children and spouses which receive a source of income should the insured individual die.
Life insurance trusts have a few significant drawbacks. These types of trusts are normally referred to as irrevocable which means the names on the trust cannot be changed after it is created. If marital issues arise or children are disowned it does not alter the fact that they will receive the proceeds from an established trust. Another issue for some individuals is that the assets placed into the trust cannot be removed or borrowed against. It is a double-edged sword that by placing assets and personal wealth in to the trust there are significant tax benefits but the downside is that they no longer having access to said assets. This goes for all assets including life insurance policies. If the value of the trust is too low it may also be difficult finding a professional trustee to administer it as the fees associated may not be incentive enough for the work involved.
For high income and high net worth individuals, life insurance trusts, and trusts in general, can provide significant tax benefits for family members and designated beneficiaries. Due to the irrevocable nature however it is important to consider the limitations involved with access to trust assets and the inability to remove trust beneficiaries. If these disadvantages are understood and the benefits outweigh the negative then a life insurance trust well provide a steady stream of income for loved ones while preventing proceeds from being taxed out of existence. Always speak with licensed professional legal advice when considering complicated financial and legal instruments to protect yourself and your family.