What is a Life Insurance Trust? And How to Set It Up?

Thang Truong
Thang Truong
Updated on:

As parents it’s natural to want to make sure your children are taken care of in all situations, especially the worst case scenarios. Whether you are new parents with a young baby or experienced ones with a special needs child, it’s scary to think about what would happen if you were to die and leave them alone in the world. Life insurance provides a way to care for your children when you are gone using a lump sum payout. But, having the life insurance policy may not be enough to ensure your children’s financial needs are taken care of after you’re gone. You may also want to combine that policy with a life insurance trust put together by an attorney.

What is a Life Insurance Trust?

A life insurance trust is a type of trust fund that contains your life insurance policy as an asset. Basically, it’s a kind of legal agreement where you, the trustor, give another person, the trustee, the right to hold onto and manage certain assets on behalf of your children, the beneficiaries. As a parent with underaged children, a life insurance trust is a useful tool for ensuring that your kids are taken care of properly. With a life insurance trust, if you pass away when your children, the beneficiaries, are still young, the insurance company will pay the policy’s death benefit to the trust, which is managed by your trustee until your children grow up to age when they can take money out of the trust.

A life insurance trust also allows you to separate monies from your estate for tax purposes and to better control distribution of the children’s inheritance. 

When people set up a life insurance trust, typically they name a trustee that they can count on to manage the money for their children. This may include a relative who will also serve as the children’s guardian or even an estate lawyer. The trustee uses the life insurance benefits to care for the children according to the parent’s wishes, such as paying the mortgage on a house off or paying school fees. 

Be Aware: Assets placed in a trust are no longer considered your property. They will be owned by the beneficiary or held by the trustee until the beneficiary is of age. Essentially, your life insurance policy becomes a separate property that isn’t considered a part of your estate.

How to Set Up a Trust?

The rules around trusts are complex, so it’s best to have an estate attorney put together your life insurance trust. The attorney will meet with you a few times to plan out the trust on paper before filling the necessary paperwork to finalize it. Every family’s trust will be different, but there is a standard procedure that most follow:

Meet with an Attorney

You’ll meet with the attorney to go over what you want to accomplish with the trust, such as paying living expenses for your children or saving the money to disburse to the children when they reach a specific age. The attorney will also ask you if you have anyone in mind to serve as the trustee. You’ll be given a list of information that the attorney needs from you in order to set up the trust. 

Obtain the Assets

Next, you’ll get the assets together that you’ll use to fund the trust. In this case, a life insurance policy. Trusts can contain both term life and permanent life insurance for the beneficiaries. 

It might be better to choose a permanent life insurance, such as a whole life insurance policy or a universal life insurance policy with a large cash-value. You can set up the policy so that monthly premiums are taken from the cash-value of the policy to avoid it lapsing if you miss a payment while sick or disabled before death. 

A “waiver of premium” rider may also be available with some whole life insurance policies allowing you to miss a payment due to sickness or injury.

>>MORE: The Case Studies of Universal Life Insurance

Finalizing the Trust

You’ll also meet with the attorney again to finalize the paperwork and make the trust official. You may need to get the signature of the trustee too. The lawyer will keep a copy of your trust paperwork, provide you with copies, and file a copy with the local county clerk’s office. There should also be some tax forms to fill out and submit to the Internal Revenue Service regarding the new tax status of your trust assets.

>>MORE: Why is Whole Life Insurance NOT Worth It?

Benefits of a Life Insurance Trust

A life insurance trust comes with other positives beyond the ability to give specific directions for how the payout is to be used. Other potential benefits include:

  • Protecting the inheritance from other people, like greedy relatives.
  • Special needs trusts keep the life insurance settlement from disqualifying your children for Medicaid or Social Security Disability Insurance.
  • Life Insurance is paid out faster to your adult trustee because many insurance companies won’t pay settlements to children.
  • A trust can protect your life insurance from being taxed if you have a large estate.

Final Thoughts:

  • A life insurance trust is a legal agreement between you and a trustee to oversee the life insurance payout for your children.
  • Life insurance trusts help parents better protect their children’s finances, especially young children and special needs children.
  • It’s best to set up a life insurance trust with an attorney.
  • The trust contains a life insurance policy that serves as its asset.
  • You won’t be able to access the life insurance policy once it is in the life insurance trust.
Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at realtor.com, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.

More Stories

6 Best Indexed Universal Life Insurance (IUL) for 2023

Are you looking for a way to set aside some extra money for your senior years, and maybe a little extra for loved ones to inherit? Most people opt for indexed universal life insurance because it offers the greatest cash value growth tied to the performance of S&P 500 index with the least risk thanks […]

Best Self-Directed Roth IRA Companies for 2023

A self-directed Roth IRA is much like a regular Roth IRA, but offers more flexibility as far as what you can invest in. Whereas a regular Roth will only let you invest in stocks, bonds, mutual funds, ETFs, and real-estate investment trusts, a self-directed Roth lets you invest in a greater variety of investment options.  […]

The 5 Best Hybrid Long-Term Care Insurance Companies for 2023

If you’ve decided to plan for every eventuality, you’d be smart to include a plan to cover long-term care. Someone turning 65 this year has an almost 70% chance of needing some type of long-term care, and about 13% of those will need it for five years or more. Long-term care is expensive and can […]

The 3 Best Traditional Long-Term Care Insurance Companies for 2023

Long term care is something that no one likes to think about, but unfortunately, many people will eventually need. Health care costs are skyrocketing, and a lengthy stay at a long-term care facility can easily bankrupt most people’s nest eggs. Long-term care insurance is one way to protect both yourself and your retirement savings. Out […]

The Best Long-Term Care Insurance Companies in California for 2023

California residents who are keen to protect themselves and their families against the worst events in life may be considering long-term care insurance. However, you might not know much about LTC insurance or how it is handled in California. Let’s take a look: What is Long-Term Care Insurance? Long-term care insurance helps pay for long-term […]

The Best Long-Term Care Insurance Companies in Arizona for 2023

Arizona is a great place to retire. It’s warm, there’s no snow to shovel, and Arizona improves the quality of life for anyone with allergies or asthma. When you pack your bags and retire to Arizona, you’re probably not thinking about long-term care. But the sad reality is that 47% of men and 58% of […]

The Best Long-Term Care Insurance Companies in Florida for 2023

There’s a lot of good reasons to retire in Florida. The weather is warm, the beaches are beautiful, and there are lots of other retirees to socialize with. Also, Florida has no state income taxes, no inheritance taxes, and no estate taxes. When you pack up your things and move to Florida, you’re probably not […]

Private Placement Life Insurance: Everything You Need to Know

If you haven’t heard of private placement life insurance, you probably don’t qualify to buy it. Private placement life insurance is typically for investors with millions in liquid cash that they need to invest for tax reasons.  What is Private Placement Life Insurance? Who Qualifies for Private Placement Life Insurance? Benefits of Private Placement Life […]

Nationwide IUL – A Strong Product With Great Features and Excellent Ratings

The Nationwide IUL product can help you either supplement your retirement income or ensure your beneficiaries future by leaving them a nice tax-free death benefit. Obviously, you have many options when it comes to IUL policies, so you want to know how does Nationwide’s policy stack up against the competition? Let’s take a look. Pros […]

Transamerica IUL – A Solid Product but High Consumer Complaint Score & Law Suits

Consumers looking to supplement their retirement income often settle on an indexed life insurance policy. These policies build cash value based on market performance and allow your heirs to enjoy a tax-free death benefit. Let’s take a look at Transamerica’s indexed universal life insurance policy and see what makes it stand apart from other such […]