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Should I Put My Life Insurance in a Trust?

Posted on: April 30th, 2014 by Debra Rahmin Silberstein

As with many questions relating to estate planning, the answer is, “it depends.”

The first place to start is your assets. In Massachusetts, estates with assets over $1 million, including life insurance, are subject to the Massachusetts estate tax. In 2014, the federal estate tax exemption is effectively $5.34 million for an individual, and $10.68 million for a married couple (‘portability’ allows a surviving spouse to utilize any unused portion of the deceased spouse’s exemption). But that’s enough about estate tax. The crux of the matter is, if you have life insurance, and your estate is taxable (i.e. all your assets, including life insurance, combined are worth more than $1 million for Massachusetts residents), then you ought to be thinking about an Irrevocable Life Insurance Trust. If your estate is not taxable, skip the next section, but read on to find out about naming your revocable trust as beneficiary of your life insurance policies.

Irrevocable Life Insurance Trusts

The primary benefit of an irrevocable life insurance trust (“ILIT”) is that it removes the life insurance policies from your estate for estate tax purposes. While many people believe life insurance is “tax free,” this actually refers only to the proceeds received by the beneficiary. While your beneficiaries do not pay income tax on the proceeds of a life insurance policy, the value of a life insurance policy is still included in your “gross estate” for estate tax purposes. An ILIT allows you to remove the life insurance policies from your estate by permanently transferring them to an “irrevocable trust.” When you die, the ILIT’s Trustee simply files a claim with the insurance company, and the company writes a check payable to the Trust. The funds are then held in trust, or distributed outright to your beneficiaries.

While the administration of an ILIT is slightly more complicated than a revocable living trust – beneficiaries must receive annual notices providing the beneficiaries with a right to withdraw the premium payments (or a portion thereof), for example, and the life insurance premiums must be paid by the trustee – ILITs can result in significant estate tax savings for people with taxable estates and sizable life insurance policies, allowing you to leave more to your loved ones.

Naming Your Revocable Trust as Beneficiary of a Life Insurance Policy

If your estate is not in the taxable range, there is still a significant benefit to naming your revocable trust as the beneficiary of your life insurance, rather than naming individuals outright. Naming the trust will allow you maximum flexibility as to how you distribute the assets to your beneficiaries. If any beneficiary is a minor, or you would rather that they did not receive a large sum of money outright, your Trustee can hold the property for their benefit, making distributions only for their “health, education, maintenance, and support.” Or if a beneficiary receives needs-based government benefits, you can name a Supplemental Needs Trust as beneficiary, to prevent the funds from rendering the beneficiary ineligible. Alternatively you could hold the funds in trust until the beneficiary graduates college, has a steady job, or earns a certain amount of money, allowing you to pass on your values to your children. Holding life insurance proceeds in trust may also protect your beneficiaries’ inheritance against creditor claims, lawsuits, bankruptcy, and other unexpected life events that threaten assets held by your beneficiaries individually.

So while the nature of your life insurance planning will depend on the size of your estate, and how you want to distribute to your beneficiaries, the chances are that naming a trust as beneficiary of your life insurance, in some capacity, is the right choice for you.