This article explains life insurance trusts, including how and when to use them.
If you understand life insurance basics, you know that your beneficiary receives the policy’s death benefit once you pass away. But what happens if you’re worried about the age, maturity, or capacity of the person you choose as your beneficiary? In this scenario, it may be worth opening a life insurance beneficiary trust.
A life insurance trust allows you to set specific terms as to how the life insurance death benefit may be used. This is especially helpful in two cases:
If you simply leave an inheritance to your minor child, their appointed guardian will be responsible for how that money is used. Perhaps the guardian would be an ex-spouse or someone you know would love your kids, but you’re not sure of their financial mindset. By setting up a trust for life insurance, you ensure your own wishes are met, such as earmarking funds for college tuition or a wedding.
An irrevocable life insurance trust (ILIT) is a smart estate planning tool to use for your death benefit. You cannot change the terms of the trust once they’re finalized, including the beneficiary. But once you’re sure of how you want the trust to work, it’s the most ironclad option for reaping all of the benefits that come with putting your life insurance in a trust.
Why put life insurance in a trust? There are several advantages to using a trust instead of simply letting the life insurance company disburse funds directly to your beneficiary.
Control how the life insurance funds are distributed. Worried that inheriting a lump sum of cash at a young age could actually hurt your child? Many people choose to set an age limit, such as 25 years old, before a beneficiary can start taking distributions. Or you could create an annual distribution to control how much is taken out at a time.
Reduce estate taxes. Leaving money through an ILIT helps to avoid estate taxes. In fact, the funds can even be used to pay estate taxes, pay off the grantor’s debt, or take care of their final expenses.
Avoid probate. Leaving any life insurance policy behind for a loved one is a good move for avoiding probate. First, the probate process can take several months before an estate is settled. Additionally, those proceedings are made public. Keeping life insurance benefits in a trust make it easier to keep an inheritance private.
Help beneficiaries keep government benefits. If your life insurance beneficiary received disability or other government benefits, then an ILIT can help them remain eligible. Your estate attorney or financial planner can help create a distribution strategy that doesn’t disqualify them in the same way a major lump sum might.
Follow these four steps to set up a life insurance trust according to your wishes.
The first step in setting up a life insurance trust is getting an online life insurance policy. Get started with a customized quote from Ethos today.