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Life insurance trust


A life insurance trust is a trust where the asset is a life insurance policy. This article describes what a life insurance policy is and explains how to set one up. It then says who pays the premiums for the policy, and lists the pros and cons of a life insurance trust.

What is a life insurance trust?

A life insurance trust is a trust where the asset is a life insurance policy. After the insured person dies, the cash from the death benefit becomes the asset of the trust, and the trustee manages it according to the terms of the trust.

Life insurance trusts are usually set up by a parent or parents to pass along their wealth to children and grandchildren. The trust gives the insured person control over how the payout from their policy is distributed and spent. It also minimizes estate taxes and probate fees.

Life insurance trusts are irrevocable trusts. This means they generally cannot be changed or ended.

How is a life insurance trust set up?

There are two main ways to set up a life insurance trust.

  1. The person who owns a life insurance policy hires an estate-planning lawyer to set up a trust. They then transfer ownership of the policy from themselves to the trust. The policy can be either personal or one provided by an employer. Couples will often take out a joint life insurance policy, with death benefits paid out on the second person’s death. The trust must be set up at least three years before the insured person’s death in order for the policy to be valid. 1
  2. A person creates a life insurance trust and the trust itself buys the life insurance policy, with the trustor as the insured person. 

In the process of setting up the trust, the trustor names at least one trustee to manage the trust. The trustee and trustor cannot be the same person. Since irrevocable trusts are complicated legal entities, it is recommended that the trustee be a professional trust manager or a trust administrator (also known as a corporate trustee) at a financial institution. 

The insured person also names the people who will receive money from it—that is, the beneficiaries. They may also want to name conditions that the beneficiaries need to meet, or spread the payments out over a certain length of time. These decisions should be talked over with the trust administrator before the person works with an estate lawyer to set up the trust.

Who pays the premiums when a life insurance policy is in a trust?

The trustor can continue to pay the life insurance premium by giving the trust a gift of money each year. The trust will be set up using a legal technique called Crummey powers, so that these gifts qualify for the annual gift tax exclusion, which in 2022 was $16,000. This means that the gift of money will not be taxed or counted toward the person’s lifetime combined estate and gift tax exemption amount (currently $12.06 million). Alternatively, a bank account owned by the trust can pay the premiums.

What are the benefits of a life insurance trust?

There are numerous advantages to putting life insurance into a trust:

  • It gives the insured person more control over how the payout from the policy is used after they die. For example, they can say that the cash from the trust can only be passed down to direct descendants, not people who have married into the family.
  • The cash value that builds up in a life insurance trust is free from income tax.
  • The cash from the policy does not go through probate, so it is available immediately after the death of the insured person. And because it avoids probate, the cash is not listed publicly.
  • It reduces probate fees and, where applicable, estate taxes. Once the trust owns the policy, any money that is paid out after the insured person’s death is not part of the person’s estate. For that reason, it is not part of the estate tax or probate calculations.
  • For those who live in states with an inheritance tax, a life insurance trust also avoids these taxes.

What are the drawbacks to a life insurance trust?

The main drawback to a life insurance trust is that it is irrevocable. This means it cannot be changed or terminated without difficulty and cost. Therefore, the person who sets one up needs to think carefully about the decision. 

In particular, the person setting up the trust should also consider who they will name as beneficiaries and what conditions those people must  meet, such as turning a certain age or finishing a college degree. If the trustor has a change of heart at a later date, or if a new beneficiary (such as another grandchild) enters the picture, the trustor will not be able to make any changes.

Related information

Assets and liabilities

Asset protection trust

Charitable trust

Creating legal documents

Engaging an attorney

Estate and inheritance taxes

Financial plans versus estate plans

Gift trust

Overview of estate plans

Overview of trusts

Protecting assets from mishandling

Protecting assets from taxes and fees

Revocable living trust

Special needs trust

End notes

 1 Incidents of Ownership. Investopedia.com.

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