Life Insurance Trust (Terms Explained)

The ability to buy a life insurance trust is one of the many benefits of buying life insurance. Life insurance trusts allow the trustee to distribute the life insurance death benefit according to the insured person’s wishes and generally cost about $750 to set up.

A life insurance trust is especially useful to parents who want to leave money to their underage children or the care of other loved ones. Read on to learn more about how life insurance trusts work.

Understanding Life Insurance Trusts

Regardless of your life insurance type, life insurance trusts work the same. Below is a detailed list of how life insurance trusts work, from the purchase and setup to the trust distribution process after you file a life insurance claim.

Life Insurance Trust Trustee Duties Flowchart

Duties	Description
Set Up	The trust is created with the help of an estate planning attorney.
Ownership	The trust becomes the owner and sole beneficiary of the life insurance policy.
Premium Payment	The trust pays for the annual life insurance premiums.
Gift Tax	If the annual premium is larger than $15,000, the donor needs to file a gift tax return with the IRS.
Administration	The trustee is responsible for administering the trust and ensuring that the proper procedures are followed, such as providing Crummey notices and obtaining beneficiary signatures.
Distribution	The trustee distributes the life insurance proceeds according to the trust terms.

The trustee of your life insurance trust can be the life insurance company or a person, such as a loved one or a lawyer. The beneficiary of life insurance trusts can also be whoever you wish, so it is up to you who you want to manage your life insurance trust and who you want to receive your trust funds.

For a full explanation of other common life insurance terms you may see on your policy, you can visit our life insurance terms and definitions guide.

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Two Basic Types of Life Insurance Trusts

There are two different types of life insurance trusts that you can choose between.

The first type is an irrevocable life insurance trust. This type of life insurance trust can’t be changed or canceled after purchase, limiting a customer’s flexibility with how they use their life insurance trust.

 

However, the benefit of an irrevocable life insurance trust is that taxes can be lowered or eliminated altogether on these trusts.

The other type of life insurance trust, a revocable life insurance trust, is more flexible. The policy owner can change a revocable life insurance trust whenever they desire, whether it’s adding beneficiaries or adding to your life insurance trust fund.

Read our guide on can you change your life insurance beneficiary for more information.

Both of these trusts have advantages and disadvantages, so it’s important to thoroughly research which is better for you before purchasing a life insurance policy trust.

Cost of a Life Insurance Trust

Life insurance trusts require an initial set-up fee and monthly payments, or the policy will become void. The average cost for a life insurance trust is as follows:

If you already have a life insurance policy with a company, it is cheaper to purchase another life insurance policy from the same company, as adding on a policy averages only $42 extra a month. Purchasing a policy from one of the best cheap life insurance companies will also help reduce monthly costs.

Circumstances When Owning a Life Insurance Trust Makes Sense

Not everyone needs to own a life insurance trust, but there are a number of situations when it makes sense to have a life insurance trust on your policy.

• You want to ensure that your beneficiaries are cared for after you pass if they can’t handle your assets independently, such as leaving a trust to fund the care of underage children or children with special needs.
• You want to control how your life insurance policy funds are handled after you pass.
• You want your life insurance policy funds to be mostly tax-free or completely tax-free to minimize the amount lost to taxes.
• You want probate avoidance, where the assets are handled outside of probate court, allowing the trust to be handled out of the public eye (read our guide on does life insurance go through probate for more information).

If you have a substantial amount of money you want to be handled by a trust rather than a less controlled method like a life insurance will, then a life insurance trust may be right for you.

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Benefits of Owning a Life Insurance Trust

There are numerous benefits to having a life insurance trust. Some of the main benefits of owning a life insurance trust are as follows:

As we briefed over earlier, one main benefit of a life insurance trust is that you can control how your beneficiaries receive funds.

For example, you could release part of your life insurance trust for a child when they turn 18, another part when they turn 25, and so on. You can read our guide on how to name a minor child as a life insurance beneficiary for more information.

Alternative Ways to Fund a Trust

A trust does not have to be funded by your life insurance policy. Some of the other ways you can fund your trust are through the following:

• Cash deposits
• Real estate investments
• Stock investments

It is up to you which is the best method for funding your trust. For example, you could only deposit cash into your trust, or you could deposit cash and use some of your stock investments as funding.

Case Studies: Exploring the Benefits of Life Insurance Trusts

Case Study 1: The Smith Family

The Smith family consists of John and Sarah, a married couple with two children. They are concerned about their children’s financial security in the event of their untimely passing. To ensure their children’s future is protected, they decide to establish a life insurance trust.

By setting up a trust, they can designate a trustee who will manage the life insurance policy’s death benefit on behalf of their children. This arrangement allows them to control how and when the funds are distributed, ensuring their children’s well-being even after they are gone.

Case Study 2: The Johnson Estate Planning

Mr. Johnson, a successful business owner, wants to minimize estate taxes and protect his assets for future generations. He decides to create an irrevocable life insurance trust as part of his estate planning strategy.

By placing his life insurance policy into the trust, Mr. Johnson ensures that the policy’s death benefit is not included in his taxable estate. This decision helps reduce the potential tax burden on his beneficiaries and preserves more of his wealth for their benefit.

Case Study 3: The Thompson Charitable Legacy

Ms. Thompson is a philanthropist who wishes to leave a lasting legacy through charitable giving. She establishes a revocable life insurance trust and names a charitable organization as the beneficiary.

By doing so, Ms. Thompson ensures that a portion of the life insurance proceeds will be directed to the chosen charity upon her passing. This strategy allows her to support a cause she deeply cares about and make a meaningful impact even beyond her lifetime.

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The Bottom Line: Life Insurance Trusts

Life insurance trusts can be a useful tool for those looking for a way to control the release of assets to beneficiaries, lessen the tax burden on their assets, and keep the allocation of funds out of public record. If a life insurance trust isn’t the right choice for you, there are also plenty of other ways to fund a trust, such as with cash deposits.

Read more: Is life insurance an asset?

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