How Life Insurance Works With Trusts [A Quick Guide]

Life insurance is a cash reimbursement given to your beneficiary upon your passing. Your beneficiary is the person you choose to receive the money from the life insurance policy.

It could be your spouse, children, friend, or family members. You can have more than one beneficiary.

In addition, you can select a charity organization as your beneficiary. However, the insurance company can only issue the cash out once you die.

Since life insurance can only be distributed after your death, it’s not considered as part of your asset. It technically belongs to your beneficiary.

Therefore, you don’t need to have a will to instruct how to use your life insurance money. A will or last testament is a legal document that gives instructions on how one would wish their assets to be distributed to their beneficiaries.

However, that doesn’t completely take away the control of your life policy. You can add your life policy to trust to give directives on how you’d like the life insurance to be used, among other things.

This article will look into trusts and how life insurance works with trusts.

Defining Trust

A trust is a legal entity that allows you to give instructions on how you would like your assets to be distributed and managed.

It’s usually arranged during your existence. You have to choose a third party, a trustee, someone other than you, and your beneficiary.

The trustee manages the trust. They are responsible for ensuring that the trust is executed according to your directives.

Therefore, with trust, you can decide:

• Who benefits from your assets of life policy
• When they can receive the benefits and
• How they can use the money or asset given to them

Generally, there are two kinds of trust; revocable trust and irrevocable trust. A revocable trust is a trust whose terms or directives can be changed at any time.

On the other hand, an irrevocable trust is the kind of trust whose terms or directives can’t be changed once they’re agreed upon.

Sometimes a revocable trust can become irrevocable. You can click this link to know how a revocable trust becomes irrevocable.

Putting A Life Insurance In A Trust

You can put your life insurance in a trust, a process also known as writing life insurance in trust.

This means that you’ve made arrangements for your life insurance to be paid to your trust and not to your beneficiary. The life insurance is then distributed to your beneficiary from the trust and by a trustee.

You may wonder, why have such an arrangement? To answer that question, remember the control discussed at the start of the article.

As mentioned before, you can’t add your life insurance policy to your will since it isn’t an asset. Ideally, life insurance is usually disbursed to your beneficiaries when you die.

Once that’s done, you don’t have a say over the money. Unless, of course, you have a written trust.

A trust helps you get your power back on your life insurance. You can control how your money will be used. For Example:

If you suspect the total amount of money paid out may be overwhelming to your beneficiary, you can have instructions for the money to be paid out in annual installments.

By doing so, you’re avoiding the possibility of your beneficiary wasting the money. You’re also ensuring that your family or loved one is provided for through a stable income stream from the life insurance money.

You can leave the money for your children. This is arguably one of the most common reasons for establishing trust.

If you would like your kids to inherit your property, but they’re too young to do so, you may assign the property to a trustee until the kids are of age.

The trustee is legally bound to honor your directives when the time comes. The same can happen with life insurance. You can have the money held in trust until your children are grown enough to manage it.

Another way trust gives you control is by allowing you to dictate where you would like the life insurance policy to be used. For example, you may want the money to be used for your children’s education.

Trusts come in handy to help you establish your directives and ensure that they’re honored.

Here are more benefits of putting life insurance in a trust:

• Payment Of The Life Insurance Is Faster

Other than having control over your money, another benefit for writing your life insurance in trust is that the money is paid out quicker.

Usually, when the money is paid directly from the insurance company to the beneficiary, it goes through the process of probate.

But with trust, it doesn’t go through probate.

Therefore, this means that the insurance company can release money into the trust as soon as the death certificate is issued.

This helps to quicken the process of paying out the life insurance money to your beneficiaries.

• It Safeguards Your Beneficiaries From Death Tax

When you put your life insurance in trust, the funds given to your beneficiaries aren’t considered as part of your property.

This means that it’s not subjected to the death tax or inheritance tax. The money is paid out directly to your beneficiaries.

Generally, assets over USD$11.7 million are charged an 18-40% tax rate, which is a lot of money you may want to save.

Types Of Trust

If you’re planning to put your life policy in trust, it would help if you first understood the types of trust.

With this, you can easily determine where you’d like your written trust to fall in.

• Discretionary Trust

This is the type of trust you use when you want to state where you want your life insurance money to go. You’re expected to list your beneficiaries in a letter.

The trustee is also expected to maintain a high level of discretion about your chosen beneficiaries. Paying the beneficiaries is also supposed to be done with the utmost discretion.

• A Flexible Trust

This type of trust works like the discretionary trust, except it has two beneficiaries: The default beneficiary and the discretionary beneficiary.

The default beneficiaries are the people entitled to the money from the life insurance, as stated by the owner.

The trustee usually appoints discretionary beneficiaries during the trust period. The money automatically goes to the default beneficiary if no discretionary beneficiaries are appointed during the trust period.

• Absolute Trust

The absolute trust allows you to name your life insurance beneficiaries. However, you aren’t allowed to make any changes in the future.

On the bright side, absolute trusts tend to process their pay-outs quicker than any other type of trust.

Additionally, life insurance money held under this trust isn’t subjected to inheritance taxing.

• Survivor’s Discretionary Trust

The survivor’s discretionary trust allows the surviving partner to get pay-outs from a joint life insurance policy once their partner dies.

If the surviving partner dies within 30 days of the first partner dying, the money is paid to other beneficiaries like family members and children.

Other than these four categories of trust, here are more ways to place your life insurance in trust:

• Irrevocable Life Insurance Trust (ILIT)

An irrevocable life insurance trust is created when the grantor is still alive to manage the life insurance policy.

However, the insurance proceeds are only paid out after the death of the guarantor following his wishes. The selected beneficiaries are permanent hence the name ‘irrevocable.’

This is one of the most common written trusts. Some ILIT provide the ownership of a second to die life.

This means that the life insurance proceeds aren’t paid out to the beneficiaries until the guarantor and a second selected person die.

• Joint Life Insurance In Trust

This type of life insurance trust is for married couples. The proceeds of the insurance are only paid once one of the partners dies. The purpose of this life insurance trust is to financially support the surviving partner.

However, once the surviving partner pays the money, they’re left without life insurance cover.

Just like the survivor’s discretionary trust, should the surviving partner die within 30 days of the first partner’s death, the life insurance proceeds should be paid to other beneficiaries.

Married couples also have the option of choosing a single life policy, a joint policy like discussed above, or a mixture of both.

The combination may be very resourceful, especially since the surviving partner is left uncovered once the joint life insurance is paid out.

While the single life insurance policy may help cover the surviving spouse and the beneficiaries.

In Summary

Life insurance seeks to provide for the people you leave behind; Be it your children, spouse, family, friends, or even a charity organization that you were committed to.

That means that life insurance proceeds can’t be paid out to your beneficiaries until your death. The life insurance money isn’t considered as part of your asset.

With life insurance, you can’t offer guidelines of how you wish the money to be used. However, if you put the life insurance in trust, you can gain your power back.

A written trust allows you to control who gets your money, how they can use it, and when they can get it. Additionally, using a written trust helps reduce the burden of inheritance tax on your beneficiaries.

Now that you know how life insurance works with trust, you may consider this process as well. All the best!