3 minute read

A Guide to Insurance Trusts

What exactly is an insurance trust? Is it the same as a life insurance trust? And how do insurance trusts work? Trust & Will explains.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

Anyone who’s ever wondered, What is an Insurance Trust? knows it can be difficult to find information that doesn't just dole out legal jargon. Here, we’re aiming to educate you on everything you need to know about an Insurance Trust - which is also known as a Life Insurance Trust or even shortened into an Ins Trust. So read on, as we cover what this specialized type of Trust is, how it works and more. 

What Is an Insurance Trust? 

An Insurance Trust is a type of Irrevocable Trust where the Trust assets consist of a life insurance policy. With Insurance Trusts, both the owner and beneficiary of the insurance policy is the actual Trust itself.

Insurance Trusts can be really beneficial on a number of fronts, especially when it comes to protecting an estate and its beneficiaries. You can use them to control how insurance policy proceeds are used after you pass away, and they can be a great resource if you want to plan strategically to avoid large estate taxes. But you’ve got to know how to use them, and what the potential drawbacks are, if you’re thinking about starting this specialized type of Trust. 

What is the Purpose of an Insurance Trust?

An Insurance Trust serves two primary goals. First, it can give the Grantor (the person who sets up and starts the Trust) incredible control over life insurance assets. But another significant benefit is that it can help reduce the dollar amount that’s lost to taxation. An Insurance Trust lets the Grantor maximize how much of the proceeds from a life insurance policy is exempt from taxes.

How Does an Insurance Trust Work?

An Insurance Trust is fairly straightforward to set up and operate.

Once it’s created, the Grantor funds it by putting their life insurance policy into it. This means that the Trust in essence now owns the policy (even though it still names the Grantor as the one who’s insured). The Trust is a legal entity that exists outside of a Grantor’s estate, and so the Trust is exempt from overall estate taxes.

When the Grantor passes away, the life insurance benefit is paid out to the Trust rather than to an individual beneficiary. The Trustee pays any expenses or taxes that may be required (though typically beneficiaries aren’t on the hook for any estate tax). A good example of a common expense that might be occurred here could include legal fees relating to the life insurance policy and the Trust execution.

In the final step, the Trustee will distribute the life insurance payout to the named final beneficiaries of the Trust. This is done following the explicit guidelines stated in the Trust documents.

What Type of Trust is an Insurance Trust?

An Insurance Trust is known as an Irrevocable Trust. With Irrevocable Trusts, there are only a few, relatively restrictive ways to make changes to the Trust. The end result is that it’s extremely difficult to modify an Irrevocable Trust after it’s been created. This is by design, and serves to protect Grantor, estate and beneficiaries from lawsuits, creditors and other threats to the estate value. 

Even the Grantor cannot make changes to the terms of an Irrevocable Trust. This is because when you create an Irrevocable Trust, you hand over the assets and control to the Trust itself. Irrevocable Trusts are particularly attractive to individuals whose professions leave them vulnerable to lawsuits. When assets are surrendered to the Trust, it ensures they’re no longer possible targets for legal judgments.

Benefits of an Insurance Trust 

The single biggest advantage of a Life Insurance Trust is that it gives the Grantor maximum control over how a life insurance payout is distributed. Although the fact that an Insurance Trust is irrevocable may sound extremely rigid, it can actually provide clarity during messy situations.

For example, if a beneficiary is incapacitated at the time of the Grantor's death, the court is authorized to intervene and supervise the distribution of the payout. The court may even choose to reduce or block the transfer of funds to the intended beneficiary due to the extenuating circumstances. A Life Insurance Trust ensures that this sort of unwanted court intervention does not happen, because the Trustee will have to pay out the funds to the beneficiaries following the Grantor's guidelines - no questions asked.

This isn't the only benefit of a Life Insurance Trust. Still, virtually all of the positives do seem to center around maximizing control and minimizing estate dilution. 

Some additional benefits may include:

  • Reducing the total volume of assets subject to estate taxes

  • Preventing life insurance proceeds from becoming part of a loved one's estate

  • Avoiding probate court entirely

  • Offering up funds faster than other methods, which can be used to pay things like estate taxes or any other unanticipated expenses

Create an Insurance Trust Today 

Now that you understand what an Insurance Trust is, how it works and where it might make sense in estate planning, it may be time to consider starting one. 

Remember that the biggest benefit with this Trust type is that it gives you as much control as possible over how your life insurance policy is distributed. It also can be used in conjunction with other aspects of your Estate Plan, so you can set up a solid plan that protects your estate while strategically ensuring that your loved ones get as much inheritance as possible.

Still have questions about Insurance Trusts or any other part of an Estate Plan? Check out what we can offer, so you can get started today.   

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