What is a Life Insurance Trust?

An Irrevocable Life Insurance Trust is an irrevocable trust that holds life insurance, and as an irrevocable trust it keeps the proceeds of the policy out of the estate of the grantor. First, let’s review the purpose of a trust, which is an estate planning tool that sets up an entity to hold and manage property or assets. The person setting up a trust is known as a grantor or settlor, the person managing the trust is called a trustee, while the person(s) benefitting from the trust is known as the beneficiary.

With a life insurance trust, the trust is set up specifically to hold and manage the life insurance policy. Normally, when an insured owns a life insurance policy, the proceeds of the policy will be subject to estate tax when he dies; but if the owner of the policy transfers ownership to an irrevocable life insurance trust that follows specific guidelines, the proceeds are free of the estate tax.

There are limitations to an irrevocable life insurance trust, such as:

  • An insured person may not serve as the trustee of a life insurance trust;
  • A beneficiary may not be changed on the policy;
  • The insured may not borrow against the policy. If the trust allows him to borrow against the policy, he will be deemed as benefiting from the policy, and thus the owner of the policy, which then subjects it to estate tax and defeats the purpose of the trust; and
  • Once you set up and fund the trust, you cannot get the policy back. If you become uninsurable, you will be committed to this trust as your only life insurance.

While there are several drawbacks, there are also several estate planning benefits, such as:

  • A properly structured irrevocable life insurance trust provides liquidity. In an estate that holds an abundance of non-liquid assets, such as real estate, a Life Insurance Trust can help pay a large estate tax bill without selling off assets;
  • Beneficiaries may be protected from future creditors by including a spendthrift provision in the trust document and granting discretion to the trustee in making distributions; and
  • Premiums on the policy can be paid with gifts to the life insurance trust from the insured and, if the trust is properly drafted, the gifts may qualify for the IRS exclusion from gift tax liability.

Trusts are a powerful estate planning tool, and an estate planning lawyer can help you determine if an irrevocable life insurance trust meets your needs.