Should Life Insurance Go Into a Trust?

Life insurance serves as a contract where an insurer provides a financial payout to designated beneficiaries upon the insured’s death. A trust, on the other hand, represents a legal arrangement where one party, known as the trustee, holds and manages assets for the benefit of another party, the beneficiary. Combining these two financial tools can create a structured approach to wealth transfer. This strategy aims to ensure that life insurance proceeds are managed and distributed according to specific wishes, extending control beyond a simple beneficiary designation.

Reasons for Trust Ownership of Life Insurance

Placing life insurance within a trust offers distinct advantages for managing wealth transfer. It can exclude proceeds from the insured’s taxable estate. Without trust ownership, payouts can be subject to federal estate taxes if the estate’s value exceeds certain thresholds. For 2025, the federal estate tax exemption is $13.99 million per individual. Properly structured trust proceeds are generally not included in the gross estate for federal estate tax purposes, leading to substantial tax savings for beneficiaries.

Trust ownership also allows for probate avoidance. When a trust owns a life insurance policy, the death benefit bypasses the probate process. This means funds can be distributed more quickly to beneficiaries, often within weeks, without the delays and public nature of court-supervised probate. Avoiding probate also helps maintain privacy regarding inheritance details, as probate records are typically public.

Trusts also provide enhanced control over how and when life insurance proceeds are distributed. Unlike direct beneficiary designations, which typically result in a lump-sum payment, a trust allows the grantor to establish specific terms for distribution. This control is beneficial for beneficiaries who are minors, have special needs, or lack financial management experience. The trust document can specify staggered distributions, direct funds for specific purposes like education, or protect assets from creditors.

Understanding Irrevocable Life Insurance Trusts

The Irrevocable Life Insurance Trust (ILIT) is the specific type of trust most frequently utilized for holding life insurance policies. An ILIT is defined by its irrevocable nature, meaning that once established, the grantor generally cannot change or terminate its terms. This permanence underpins its effectiveness in estate planning.

An ILIT involves three main parties. The grantor creates and funds the trust, typically the insured. The trustee manages trust assets, including the life insurance policy, and distributes proceeds according to the trust agreement. Beneficiaries receive the trust assets, including the life insurance death benefit, upon the grantor’s death.

The irrevocability of an ILIT is fundamental to its primary objective: excluding life insurance proceeds from the grantor’s taxable estate. By relinquishing ownership and control of the policy to the trust, it is no longer considered part of the grantor’s personal estate. This separation allows the death benefit to pass to beneficiaries free of federal estate taxes, assuming proper structuring and adherence to legal requirements.

Life insurance policies are typically funded into an ILIT in one of two ways. The trustee can apply for a new policy directly, with the trust named as the owner and beneficiary. Alternatively, an existing policy can be transferred by the grantor into the ILIT. When an existing policy is transferred, a “three-year rule” applies: if the grantor dies within three years of transferring the policy, the death benefit may still be included in their taxable estate. This rule emphasizes early planning when transferring an existing policy.

Administering a Life Insurance Trust

Setting up and maintaining a life insurance trust involves preparatory and procedural actions. Selecting a suitable trustee requires careful consideration. The trustee manages the trust and its assets, including the life insurance policy, and distributes proceeds. While a family member can serve, a professional or corporate trustee may offer advantages due to their experience, impartiality, and longevity. The selected trustee should be trustworthy, financially astute, and capable of maintaining accurate records.

Gathering comprehensive information is another preparatory step. This includes details about the life insurance policy, such as its type and terms, along with intentions for how beneficiaries should receive funds. If a new policy is acquired, the trustee typically handles the application, ensuring the trust is named as owner and beneficiary from the outset. For an existing policy, the grantor must execute an assignment or transfer of ownership form, officially changing the policy’s owner to the trust. This step ensures policy proceeds are excluded from the grantor’s estate.

Once the trust is established and policy ownership formalized, ongoing procedural actions are necessary. Premium payments for the life insurance policy are typically made by the grantor gifting funds to the trust. The trustee then uses these gifted funds to pay the premiums. To qualify these gifts for the annual gift tax exclusion, specific procedures must be followed.

A common procedural requirement involves issuing “Crummey notices” to beneficiaries. These notices inform beneficiaries of their temporary right to withdraw gifted funds within a specified period, usually 30 days. This withdrawal right, even if not exercised, allows gifts to qualify for the annual gift tax exclusion ($19,000 per recipient for 2025). The trustee is responsible for sending these notices and maintaining records.

The trustee’s responsibilities extend beyond premium payments and Crummey notices. They include managing other trust assets, ensuring the policy remains in force, and periodically reviewing its performance. Upon the grantor’s death, the trustee collects the death benefit from the insurance company and distributes funds to the beneficiaries according to the trust document. This ongoing oversight helps ensure the trust fulfills its intended purpose.