What Is a Variable Insurance Trust and How Does It Work?
Demystify Variable Insurance Trusts. This guide explains their purpose, function, and key role in modern estate planning.
A Variable Insurance Trust combines a specific type of life insurance with a legal trust structure. For individuals, it typically involves an Irrevocable Life Insurance Trust (ILIT) designed to hold a variable life insurance policy. This arrangement aims to provide financial security and facilitate wealth transfer outside of the probate process.
Understanding the Core Components
An Irrevocable Life Insurance Trust (ILIT) is a legal arrangement where a trustee holds assets for designated beneficiaries. A grantor establishes this trust and transfers assets into it. The trust defines how these assets are managed and distributed.
Variable life insurance is a permanent life insurance form combining a death benefit with an investment component. Its cash value fluctuates based on the performance of underlying investment sub-accounts. These sub-accounts invest in securities like stocks, bonds, and mutual funds, offering growth potential with market-related risks.
How a Variable Insurance Trust Functions
An Irrevocable Life Insurance Trust (ILIT) functions by becoming the legal owner and beneficiary of a variable life insurance policy. The grantor funds the trust with cash gifts, which the trustee uses to pay the policy premiums.
By owning the policy, the ILIT removes the death benefit from the grantor’s taxable estate, potentially reducing federal estate tax liability. The trustee manages the variable life insurance policy, including making premium payments and overseeing investment choices within the policy’s sub-accounts.
Upon the death of the insured, the death benefit from the variable life insurance policy is paid directly to the ILIT. The proceeds bypass the probate process, allowing for a quicker and more private distribution to the ultimate beneficiaries. The trust document dictates the terms and conditions for how and when these proceeds are distributed, offering the grantor control over the legacy left to their heirs.
Key Characteristics of a Variable Insurance Trust
The defining feature of an Irrevocable Life Insurance Trust (ILIT) holding a variable life insurance policy is the transfer of policy ownership from the individual to the trust. This means the trust, through its appointed trustee, holds legal title to the policy and exercises control over its management. The grantor relinquishes direct control over the policy once it is transferred to the trust.
Variable life insurance policies within an ILIT offer investment flexibility, allowing the cash value to be allocated among various sub-accounts that invest in diverse assets. This provides an opportunity for potential cash value growth linked to market performance. However, this investment component also introduces market risk, meaning the cash value can decrease if the underlying investments perform poorly.
Most ILITs are established as irrevocable trusts, meaning the grantor generally cannot modify or terminate the trust once it is created. This irrevocability is fundamental to achieving the trust’s estate tax benefits, as it ensures the policy proceeds are not considered part of the grantor’s taxable estate. The assets held within an irrevocable trust are typically protected from creditors and legal judgments against the grantor.
The parties involved in an ILIT include the grantor, who creates and funds the trust; the trustee, who manages the trust assets and the policy according to the trust document; and the beneficiaries, who receive the distributions from the trust. The trustee can be an individual, such as a family member or trusted advisor, or a corporate trustee, like a bank or trust company. The careful selection of a trustee is important, as they bear fiduciary responsibility for managing the trust for the beneficiaries’ best interests.
Establishing a Variable Insurance Trust
Establishing an Irrevocable Life Insurance Trust (ILIT) with a variable life insurance policy involves several critical decisions to align the trust with the grantor’s estate planning goals. A primary decision is selecting a trustworthy and capable trustee who will manage the policy’s investments and administer distributions according to the trust’s terms. Identifying the specific beneficiaries and outlining the precise conditions under which they will receive distributions is also a foundational step.
Determining the appropriate death benefit amount for the variable life insurance policy is another key consideration, as this influences premium costs and the financial provision for beneficiaries. The grantor must carefully consider their long-term financial objectives and the anticipated needs of their heirs. This process involves outlining the trust’s comprehensive terms, including investment guidelines for the variable life policy’s sub-accounts and detailed distribution rules.
The primary legal document required is the trust agreement, which must be meticulously drafted by legal counsel to ensure it adheres to applicable trust laws and accurately reflects the grantor’s wishes. This document specifies the trustee’s powers, the beneficiaries’ rights, and the conditions for asset distribution. Concurrently, an application for the variable life insurance policy will be completed, with the ILIT designated as the policy owner.
Information gathering from the grantor includes personal financial details, family structure, and specific estate planning objectives. The chosen trustee will also need to provide necessary identification and compliance information. For beneficiaries, basic identifying information is required to ensure proper designation within the trust document.