Life Insurance Inside of Trusts

Life insurance can serve a variety of purposes. In its most basic sense, this important financial vehicle provides proceeds to loved ones and survivors for the payoff of debt, the continuation of ongoing living expenses, and/or for other personal and business needs. But life insurance can also play a major role when it comes to…
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Life insurance can serve a variety of purposes. In its most basic sense, this important financial vehicle provides proceeds to loved ones and survivors for the payoff of debt, the continuation of ongoing living expenses, and/or for other personal and business needs.

But life insurance can also play a major role when it comes to estate planning. This is because life insurance can provide both funding and flexibility. This is particularly the case when it comes to the use of life insurance inside of trusts.

One of the primary reasons that people put life insurance inside of trusts is to help with the payment of estate taxes – which can sometimes be as high as 55% of the decedent’s estate value. These taxes are due from the state, typically within nine months of the individual’s death.

Oftentimes, family members will have to sell assets – which could include precious family heirlooms – in order to raise the money for paying estate taxes. However, provided that it is structured properly, not only can life insurance proceeds pay this bill, but the amount of the life insurance policy itself will not be included in the value of the decedent’s estate.

How Trusts are an Important Estate Planning Tool

Trusts are an important tool in the estate planning process. One reason for this is because a trust can help to remove taxable assets from your estate, in turn, lessening your potential estate tax liability.

Typically, when used in this manner, the trust will be the owner of the insurance policy (thus removing the proceeds from the overall estate value). This, in turn, helps to reduce the value of the estate, which is what the amount of estate tax is based upon.

One of the most commonly used types of life insurance-related trust is the ILIT or Irrevocable Life Insurance Trust. This type of trust can protect the cash value in life insurance policies from creditors during your lifetime, and then it can further protect the proceeds of the life insurance policy upon death.

When using an ILIT for estate planning purposes, the trustee will purchase the insurance policy, naming the trust as the owner, as well as the beneficiary. Once the insured has passed away, and the life insurance proceeds have been paid out, the trustee will collect the funds and make them available for paying the estate taxes that are due, as well as other costs, which may include income taxes due, legal fees, probate costs, and other related expenses. The trustee will then also distribute funds to trust beneficiaries as previously instructed by the insured.

Any person or entity may be a beneficiary of the trust. In many cases, an individual will name their loved ones, such as children and/or grandchildren. But they could also name a favorite charity or other organization, depending on their goals.

It is important to note that there is a “look back” period, typically of three years. This means that if the insured dies within three years of the date that assets were transferred into the trust, then the IRS (Internal Revenue Service) will consider the transfer to be invalid, and the amount of the insurance proceeds will be included in the insured’s estate for estate taxation purposes.

Also, as an ILIT is irrevocable, changes typically cannot be made once the trust has been set up and funded. Therefore, it is important to be sure of how the insured wants his or her money to be transferred. In this case, it is also important to seek the assistance of a professional who is familiar with life insurance trusts and estate planning.

Because everyone’s wishes are different, there are other types of trusts that can also be set up using life insurance, depending upon your particular needs. These may include the following:

  • Charitable Remainder Trust (CRT) – For the donor, a Charitable Remainder Trust, or CRT, can help to reduce taxes. This is accomplished by the donor contributing assets into the trust, and then having the trust pay the beneficiary for a certain period of time. Then, after this set period has ended, the remainder of the estate can be transferred to the charity that is named as the beneficiary.
  • Qualified Terminable Interest Property Trust (QTIP) – With an inter vivos Qualified Terminable Interest Property (QTIP) trust, the grantor is allowed to provide for his or her surviving spouse, as well as to maintain control of how the trust’s assets will be distributed once the surviving spouse has passed away. The income – as well as sometimes the principal – that is generated from this type of trust is given to the surviving spouse in order to make sure that they are taken care of for the remainder of their lifetime.

Why Consider Life Insurance Inside of Trusts?

Life insurance is a common financial tool that is used inside of trusts. One of the key reasons for this is because life insurance can provide the funding that is needed – often for pennies on the dollar. In other words, the premium that is paid into a life insurance policy is typically much less than the actual amount of benefits that are received.

There can also be a considerable amount of tax-related advantages when using life insurance as a funding mechanism – both when paying the premium, as well as when receiving the policy’s proceeds.

Some of the other benefits that are inherent by using a life insurance trust include the following:

  • The availability of immediate funds for paying estate taxes (as well as other expenses after the insured’s passing)
  • The removal of the life insurance proceeds from the insured’s estate
  • The avoidance of probate of the life insurance proceeds
  • The receipt of the life insurance proceeds free from income taxation
  • The control that the insured has over how the life insurance proceeds will be used
  • The ability to provide income to a surviving spouse – yet without the life insurance proceeds being included in his or her estate

What Type of Life Insurance Should Be Included in a Trust?

It is typically recommended that permanent life insurance be used with a trust. This is because, unlike term life insurance, there is no time limit, or term, on the policy period. Therefore, provided that the premium is paid, a permanent life insurance policy will remain in force and will be there when it is needed.

Who Should Consider a Trust Using Life Insurance?

While the use of trusts in financial or estate planning may not be right for everyone, if you are considering setting up an estate plan, you could benefit from having life insurance included with your trust(s).

This is because life insurance can provide benefits not only for your immediate survivors but also for many generations to come. And, the proceeds from a life insurance policy are received free of income tax by the beneficiaries. With that in mind, 100% of the proceeds will typically be available for your survivors’ financial needs.

Where to Learn More About Incorporating Life Insurance Inside of a Trust

If you would like to know more about incorporating life insurance inside of a trust, we can help. Our experts will walk you through the various scenarios that may best fit your specific planning needs.

Please feel free to reach out to us! We understand that using life insurance and trusts in estate planning can be somewhat confusing. But working with an expert can help you in determining what tools will be right for you. So, contact us today – we’re here to help.


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About Ryan Guina

Ryan Guina is The Military Wallet's founder. He is a writer, small business owner, and entrepreneur. He served over six years on active duty in the USAF and is a current member of the Illinois Air National Guard.

Ryan started The Military Wallet in 2007 after separating from active duty military service and has been writing about financial, small business, and military benefits topics since then. He also writes about personal finance and investing at Cash Money Life.

Ryan uses Personal Capital to track and manage his finances. Personal Capital is a free software program that allows him to track his net worth, balance his investment portfolio, track his income and expenses, and much more. You can open a free Personal Capital account here.

Featured In: Ryan's writing has been featured in the following publications: Forbes, Military.com, US News & World Report, Yahoo Finance, Reserve & National Guard Magazine (print and online editions), Military Influencer Magazine, Cash Money Life, The Military Guide, USAA, Go Banking Rates, and many other publications.

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  1. Church says

    A highly debated subject in the personal finance community, but permanent life insurance (for the right individual and if structured properly) is such a valuable vehicle in one’s estate. This is a great article on how a permanent life insurance policy can benefit one’s family in multiple ways.

    Not only is permanent life insurance a great benefit after a loved one has passed, it is a very versatile financing vehicle that can be used while one is alive and well. It certainly isn’t an investment that one should put all their eggs into, but absolutely should be incorporated in one’s portfolio. I say this as an owner of multiple policies, not as an agent or one who is affiliated with an insurance company for proceeds.

    Great post! I enjoyed reading very much.

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