“How to Set Up and Benefit from Life Insurance Trusts”

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How Does a Life Insurance Trust Work?

Life insurance can provide financial security for your dependents and loved ones. The death benefit from your policy can support your family if you pass away unexpectedly. However, what if the death benefit has to go through a lengthy probate process? Or if you want to minimize estate taxes to leave more funds for your heirs?

In such cases, a life insurance trust can be beneficial. A life insurance trust, or insurance trust, is a trust funded with life insurance that ensures your death benefit is paid out to your beneficiaries according to your wishes.

Types of Life Insurance Trusts

There are two main types of life insurance trusts: irrevocable life insurance trusts (ILITs) and revocable life insurance trusts (RLITs). Both types allow your trustee to distribute funds from the trust to specific beneficiaries as per your instructions. This setup is often preferable to a non-trust arrangement, where your property goes through probate court, which can be time-consuming and costly.

Understanding the differences between irrevocable and revocable life insurance trusts is crucial:

• Irrevocable Life Insurance Trusts (ILIT): Once established, changes are not allowed. The trust owns all assets, and federal estate taxes may be avoided if the estate’s value doesn’t exceed the federal limit.
• Revocable Life Insurance Trusts (RLIT): Changes can be made by the grantor. The insured controls the trust and its assets, but it may be subject to taxes.

Pros and Cons of Life Insurance Trusts

Advantages

• Reduces estate tax liability: Assigning ownership of your insurance policy to an ILIT separates it from your estate, potentially reducing or eliminating federal estate taxes.
• Protects assets: With an ILIT, creditors may not pursue your assets except in cases of fraud.
• Bypasses probate: Both revocable and irrevocable trusts allow you to assign a trustee to distribute assets as you wish, enabling beneficiaries to receive proceeds sooner.
• Preserves family wealth: High-net-worth individuals often use irrevocable trusts to protect wealth across generations through tax-advantaged asset transfers.

Disadvantages

• Loss of control: Once your policy is transferred into an ILIT, you can’t move it to a different trust or make other changes, though you can change the trustee if needed.
• Costly setup: Creating an ILIT through an estate or trust attorney can be expensive. A revocable life insurance trust may be more affordable and less complicated to set up.

How to Set Up a Trust for Life Insurance

Follow these steps to set up a life insurance trust to ensure your policy’s death benefit and financial assets are allocated according to your plan:

1. Consult an estate attorney or use estate planning software: Legal software can help set up a life insurance trust, but working with an estate attorney is recommended for more complex estates.
2. Designate roles for the trust: Assign a reliable trustee, name your beneficiaries, and appoint a financial manager for any minor beneficiaries.
3. Draw up the trust: Work with an estate planning attorney to create your documents and ensure they are filed correctly.
4. Fund the trust: Choose a term or whole life insurance policy that provides sufficient coverage for your beneficiaries.

The Bottom Line

Setting up a life insurance trust can help you transfer wealth to your heirs in a tax-efficient manner. Instead of leaving your estate to the probate process, a trust ensures your property and assets are distributed according to your wishes.

While making end-of-life plans may not be enjoyable, your heirs will appreciate having a clear plan to secure their financial future and avoid potential legal issues. Consider working with a financial advisor or estate planning attorney to design a plan that best serves your unique needs.

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