As we’ve said before, trust funds aren't just for rich people. There are many trust fund benefits for an average family. For example, if you have a life insurance policy, there are a number of benefits to using different types of trusts to hold that life insurance policy.
We’ve discussed previously the advantages of setting up an ILIT (irrevocable life insurance trust) for your life insurance policy. But you may want more flexibility than what an irrevocable trust allows. If that’s the case, you should consider having a living trust (also called an inter vivos trust) for your life insurance.
A living trust is a trust that you set up and takes effect while you are still living. Most living trusts are revocable, which means they may be modified or eliminated during your lifetime. Unlike an irrevocable trust, which can’t be modified once executed, with a revocable living trust you retain control over the trust and your property while living, and your family is provided for privately after your passing.
Trusts offer some key advantages
Putting your life insurance policy in a revocable living trust offers a number of advantages: privacy, providing for minor children, being able to control the distribution of benefits, and giving your heirs access to liquid assets to manage your estate, among other things.
A revocable living trust has the flexibility that an irrevocable trust does not, which makes it ideal for managing a changing estate and assets over time. Revocable trusts can be modified or done away with—you can change the beneficiaries, the assets in the trust, or even transfer the assets from a revocable trust to an irrevocable trust.
This kind of flexibility is important to those whose life circumstances, assets, beneficiaries, and other factors may change over their own lifetime.
Although details of life insurance policies are not generally publicly available, there are some situations in which that information could become public. And there are some clear reasons why you want to keep information on the beneficiaries and amount of life insurance benefits private—it could easily lead to others trying to take advantage of your beneficiaries.
With a normal insurance policy, without a trust, information about the policy could become public if you make your estate the beneficiary of your life insurance in your will, if you divorce and details about life insurance become part of public record, if your named beneficiaries are no longer living when you pass, or if your estate is probated.
Trust assets do not pass through probate, or otherwise become a matter of public record, so the information about the life insurance benefits remains private unless you or the beneficiary disclose it.
Beneficiaries with special needs
If you have a special needs child or another dependent that will need long-term care, putting your life insurance in a trust can ensure that they have the financial support they need over a long period of time without potentially threatening any government assistance they may receive.
With a beneficiary who is receiving disability checks, for example, they generally cannot have more than a certain amount in assets to qualify for government assistance. If the money is held in trust, they can receive monthly payments from the trust to supplement their income without being disqualified from programs like Medicaid, disability payments or federal or state health insurance programs.
Protection for beneficiaries against themselves
If the intended beneficiary of your life insurance policy will be a loved one who is a spendthrift or for whatever reason may need help managing their money (such as younger children), a trust allows for the slow disbursement of assets from the life insurance death benefit over an extended time or subject to certain conditions.
You could instruct the trustee, for example, to only pay out a certain amount each month, or to only use the money to pay for college expenses, marriage or a first home.
This way, you can make sure that your loved ones are provided for over a long period of time rather than allowing them to potentially burn through a lump sum in a matter of years.
You can name minor children as beneficiaries in your life insurance policy, but they cannot receive the life insurance death benefit payment until they are of age—depending on the state, that could be age 18 or 21.
With a trust, you can make sure that any minor children receive payments from the life insurance proceeds no matter what their situation is after you pass away. This is especially important if both parents die simultaneously or if you are single or divorced and your children are named as the only beneficiaries.
You can decide to continue to make payments gradually to the child once they attain majority age so that they do not spend the money all at once.
If there is no trust, the money generally passes to whoever is appointed as the child’s guardian, to hold for the minor and pay for their expenses until the child reaches majority age.
Provide cash to keep family business going
If you run a family business that will be continued by your heirs after your death, there may not be enough liquid assets that are part of the estate to assist if the business needs an injection of cash.
Having life insurance proceeds pay into a trust upon your death provides easy access to liquid assets to your beneficiaries so that they can keep the family business above water if necessary. The assets from the life insurance death benefit do not need to pass through a probate process or wait for the distribution of assets from the will.
Provides funds for the settlement of your estate
There are often costs involved with settling an estate, such as administrative costs or debts that need to be resolved. Having a revocable life insurance trust gives your estate liquidity, providing funds to pay administrative expenses, debts, final income taxes, and other costs associated with the settlement of your estate.
Many times estates do not carry much in liquid assets, so having easy access to cash can reduce the burden on your heirs in closing out the estate, rather than forcing them to sell some of the estate assets.
The provision that allows a trustee to make payments to the estate should be just that—a provision that allows. Some trusts require the trustee to make those payments, which could potentially expose the life insurance proceeds to creditors.
What a revocable living trust does not do
The only drawbacks to a revocable living trust for your life insurance policy are possibly the cost to set it up, and estate tax considerations.
There are costs associated with setting up and managing a trust, though the costs are well worth it if the result is privacy and financial security for your heirs.
Also, your trust assets may be included in your estate for tax purposes, so if your estate is too large, you should consider an ILIT instead. The proceeds from your insurance are not included in your estate if they are in an irrevocable life insurance trust.
Only about 1% of estates in the U.S. are subject to federal estate taxes, so for the great majority of cases concerns about estate taxes do not apply. The cutoff for estate tax depends on the year of death—for example, for a person who dies in 2017, the federal estate tax is only applicable if your estate is worth $5.49 million or more per person, and $10.98 million or more per married couple. Different states of course have different thresholds, so make sure you know what the limits are in your state.