Funding a Trust With Life Insurance

Benjamin Long October 14, 2020Assets, Exemption

Understanding the Role of Life Insurance in Trust Funding

“Estate planning is all about ensuring that your wishes are met after your death. All estate plans should include a will and powers of attorney. However, in many cases, a trust has additional benefits beyond what can be accomplished with the will and powers of attorney.”

The Basics of Trusts and Their Purpose

How would funding a trust with life insurance work, and could it be a good option for you? A recent article in Forbes “How to Fund a Trust With Life Insurance” explains how this works. Let’s start with the basics: a trust is a legal entity where one party, the trustee, holds legal title to the assets owned by the trust, which is managed for the good of the beneficiary. There can be more than one person who benefits from the trust (beneficiaries) and there can be a co-trustee, but we’ll keep this simple.

The Advantages of Funding a Trust with Life Insurance

Trusts are often funded with a life insurance policy. The proceeds of the policy provide the beneficiary with assets that are used after the death of the insured. This is especially important when the beneficiaries are minor children and the life insurance has been purchased by their parents. Placing the insurance policy within a trust offers more control over how funds are used.

Types of Trusts and Their Implications

What kind of a trust should you consider?

Revocable vs. Irrevocable Trusts: Pros and Cons

All trusts are either revocable or irrevocable. There are pros and cons to both. Irrevocable trusts are better for tax purposes, as they are not included as part of your estate. However, with an $11.58 million federal exemption in 2020, most people don’t have to worry about federal estate taxes. With a revocable trust, you can make changes to the trust throughout your life, while with an irrevocable trust, only a trustee can make changes.

Navigating Taxes in Estate Planning

Note that, in addition to federal taxes, most states have estate taxes of their own, and a few have inheritance taxes. When working with an estate planning attorney, they’ll help you navigate the tax aspect as well as the distribution of assets.

The Popularity of Revocable Trusts in Estate Planning

Revocable trusts are the most commonly used trust in estate planning. Here’s why:

Benefits of Revocable Trusts

Revocable trusts avoid probate, which can be a costly and lengthy process. Assets left in the revocable trust pass directly to the heirs, far quicker than those left through the will. Because they are revocable, the creator of the will can make changes to the trust as circumstances change.

Flexibility and Control in Estate Planning

This flexibility and control make the revocable trust more attractive in estate planning.

Ensuring Your Life Insurance Trust Functions as Intended

If you are using life insurance to fund the trust, be sure the policy permits you to name beneficiaries, and be certain to name beneficiaries. Missing this step is a common and critical mistake. The beneficiary designations must be crystal clear.

Naming and Updating Beneficiaries

If there are two cousins who have the same name, there will need to be a clear distinction made as to who is the beneficiary. If someone changes their name, that change must be reflected by the beneficiary designation.

Other Trust Options and Finding the Right Fit

There are many other types of trusts, including testamentary trusts and special needs trusts. Your estate planning attorney will know which trust is best for your situation. Make sure to fund the trust and update beneficiary designations, so the trust will achieve your goals.

Reference: Forbes (Sep. 17, 2020) “How to Fund a Trust With Life Insurance”