If you have loved ones and want to ensure they are well protected even when you die, establishing a life insurance trust is the right choice. Trust can be a strong way to protect your family’s future.
In addition, this legitimate contract includes a trustee who authorizes assets for your beneficiaries. A well-known approach to fund trust is to secure a life insurance policy that offers funds and support for your beneficiaries when you pass away.
What is a Life Insurance Trust?
A life insurance trust is a legal contract that enables a third party to authorize the death benefits arising from a life insurance policy. Additionally, trust makes sure that your death benefit from your policy is shared with your beneficiaries according to your desires.
Moreover, it also neglects charges from probate and might decrease any owed estate tax. Life insurance trusts are usually utilized among individuals with significant assets and also among parents who want to organize the benefits for their kids.
How Does it Work?
This insurance becomes the owner of the life insurance policy, while the beneficiaries are identified as the insured party. After your passing, the trust obtains the death benefit from the policy, and the trustee shares the funds with your beneficiaries based on the terms of the agreement.
Additionally, you can establish a life insurance trust with either a term or permanent life policy. However, whole life insurance is usually common due to its clearly defined and guaranteed death benefit.
Unlike term policies that may expire, you can leave the policy without funding it. Also, universal life policies might differ in value, making it challenging to predict the trust’s funding.
Types of Life Insurance Trusts
Generally, there are two types of life insurance trusts, which are highlighted below.
Irrevocable Life Insurance Trust
An irrevocable life insurance trust (ILIT) is a form of trust designed to keep and direct life insurance policies. However, “irrevocable,” according to its name, simply means that it cannot be altered or revoked once it’s established.
For instance, assume an ILIT is like a secure box where you deposit your life insurance policy; once deposited inside, there’s no room for changes or adjustments. But giving up has its advantages.
Creating an irrevocable trust offers the potential to prevent estate taxes and creditor claims, ensuring more significant assets for the beneficiaries of your life insurance trust.
Revocable Life Insurance Trust
A revocable life insurance trust (RLIT), also referred to as a living trust, is unlike an irrevocable life insurance trust (ILIT), in which the beneficiary can modify or cancel it at any time.
Additionally, you can also have control over the life insurance policy and adjust the trust’s obligations as needed. The trust only becomes irrevocable either upon your death or if you are not capable.
However, it’s important to note that RLITs do not provide similar tax benefits as ILITs. As the beneficiary gains control over the life insurance policy, it remains their estate, making it subject to estate taxes after their demise. (Estate taxes apply to significant estates.)
Steps To Fund a Life Insurance Trust
Generally, here are the steps to follow:
Choose the Type of Trust
There are two types of life insurance trusts, which are irrevocable and revocable. However, we are evaluating factors like financial circumstances and objectives in estate planning that can assist you in making a suitable choice.
Select a Beneficiaries
Upon choosing the type of trust policy that suits your requirements, the next step is selecting the beneficiaries of the policy. Also, consider which family members should obtain the benefits and the distributed amounts for each.
Moreover, trust indicates how the funds are to be utilized, whether for educational expenses, medical costs, or other financial responsibilities. For instance, if you own a child with special needs, a life insurance trust can serve as a valuable method to secure their future.
Furthermore, by establishing unique requirements, a life insurance trust provides an approach to meeting your child’s requirements. While safeguarding their eligibility, they also get to receive Medicaid or Supplemental Security Income (SSI).
Determine the Amount of Insurance Needed
Calculating the right amount of life insurance is a simple approach to assessing your coverage requirements. It involves using a life insurance calculator. Additionally, there are various approaches you can use, such as the DIME approach.
The DIME approach utilizes debts, income, mortgages, and education to estimate life insurance requirements. However, it doesn’t consider savings or other expenses, such as child care.
Additionally, the amount of coverage required will determine your family’s present and future finances. For instance, if you own young kids, purchasing more protection becomes the right to ensure the trust offers for their future educational requirements.
Furthermore, other factors include inflation, estate taxes, funeral expenses, and potential legal fees associated with trust administration. Lastly, consulting with an expert financial advisor can help you create a life insurance plan that aligns with your specific requirements.
Choose the Type of Life Insurance
When creating this insurance, it’s advisable to choose a permanent policy that doesn’t depreciate. Nevertheless, if expense is an issue, a term life insurance policy is more economical, offering potential advantages to the trust.
However, it’s important to note that the disadvantage of relying on term life insurance lies in the potential of outlasting the fixed term, leading to renewal costs. Collaborating with a financial advisor becomes essential in determining the best life insurance to fund your trust.
Purchase Life Insurance
Searching for various life insurance quotes is essential. When purchasing a permanent life insurance policy, also consider the policy fees and the increase in your cash value.
High policy fees can reduce your cash value over time. However, it is advisable to collaborate with an experienced financial advisor or agent to comprehend the expenses of the policy beyond the premium quote.
Typically, the life insurance policy application process involves a medical examination and an evaluation of your health and lifestyle practices.
Transfer Ownership of the Policy to the Trust
Typically, the grantor is required to sign a form provided by the insurance company that presents details about the trust. This procedure is frequently done by a professional estate planning attorney, ensuring the accurate filing of all legal documents and paperwork.
Upon the successful transfer of ownership, the trust assumes responsibility for making premium payments, covering the death benefit, and authorizing all aspects of the policy.
Is Life Insurance Right for me?
For certain individuals, establishing a life insurance trust might not be essential. However, creating an irrevocable life insurance trust involves a significant investment, and the tax benefits associated become financially reasonable if you have a significant net worth.
Moreover, if you have young children or a child with special requirements, involving a revocable trust could be the right choice. Also, trust allows you to control the timing and disbursement of funds, ensuring sustained support for minor or unique requirements. It also prevents young adults from depleting the funds all at once.
Creating a life insurance trust can help maintain a child’s eligibility for government aid, particularly for those with special requirements. Also, since the trust owns the life insurance funds, they might not be considered when evaluating income limits set by assistance programs.