Can proceeds from a life insurance policy be directed to a trust?
Life Insurance is an essential tool for both estate planning and financial planning. Early in life, life insurance can provide the financial safety net that many people do not have. Life insurance can play a vital role in an estate plan as people age. It can provide a funding source, or add assets to a trust. This strategy is most common when the policyholder wishes to meet specific financial obligations, such as providing for minor children, paying funeral expenses, or meeting the needs of beneficiaries who have unique circumstances. With that in mind, the Indianapolis attorneys at Frank & Kraft discuss how the proceeds of a life insurance policy can be directed to a trust.
The Role of Life Insurance in Estate Planning
While there are many different types of life insurance, all life insurance policies share some fundamental characteristics. A life insurance policyholder chooses a policy with a death benefit, and names an insured person as well as at least one beneficiary. The death benefit is meant to be paid out to the beneficiary after the insured dies, providing financial relief for the surviving loved ones. Some policies have a fixed death benefit, while others can fluctuate depending on factors like investment performance. Some policies accumulate cash values that the policyholders can borrow or withdraw during their lifetime. This gives them more flexibility in their financial planning. This type of protection gives parents the peace of mind to know that their children’s needs will be met even if they are not around. Life insurance is useful in many other situations, including funding a Buy/Sell agreement to ensure that a small business continues to operate or that the remaining partners are able buy out the deceased partner’s share. Additionally, life insurance can fund funeral and burial costs, providing a structured way to handle end-of-life expenses as part of a comprehensive estate plan.
Advantages of Naming a Trust as the Beneficiary of Life Insurance Proceeds
When purchasing life insurance, policyholders must name at least one beneficiary. A person is usually the beneficiary, but it is possible to name a charity, religious organization, or trust. Many people choose to name a trust as the beneficiary for strategic reasons, especially if their estate planning goals involve the protection of minor children or other vulnerable beneficiaries.
For example, if the policyholder has minor children, designating a trust as the beneficiary allows the policyholder to ensure that the death benefit will be managed and disbursed according to their wishes. Minors are not allowed to inherit directly from an inheritance, so without a trust the proceeds could be held by a guardian appointed by the court until the child reaches majority. By assigning life insurance proceeds into a trust, policyholders can select a Trustee who will oversee the funds and preserve and manage them for the benefit of the child according to the trust agreement. This arrangement provides peace of mind, knowing that the funds are protected and that a designated Trustee will manage the resources responsibly.
Naming a trust as the beneficiary of a life insurance policy can also be beneficial in other situations, such as when the policyholder creates an Irrevocable Life Insurance Trust (ILIT). An ILIT is a type of trust that holds life insurance policies to receive death benefits at the death of the policyholder. An ILIT cannot be revoked or modified once it is created, which makes it a valuable tool to reduce estate taxes and ensure that the proceeds of the policy are not included in the policyholder’s estate. Additionally, an ILIT can include provisions for specific uses of the life insurance proceeds, such as covering funeral expenses, which allows the policyholder to exercise control over how the funds are used even after they pass away.
Tax Implications of Life Insurance Proceeds When a Trust Is the Beneficiary
An important consideration when naming a trust as the beneficiary of a life insurance policy is the potential impact on estate taxes. In general, if an individual is named as the beneficiary of a life insurance plan, the proceeds will not be subject to federal estate tax. The proceeds of a life insurance policy that names a trust as the beneficiary may be included in taxable estate value if the trust is the beneficiary. This can lead to estate tax obligations if the total estate value exceeds the federal or state exemption thresholds.
The type of trust plays a pivotal role in determining the tax treatment of life insurance proceeds. If the trust is a trust that can be revoked, for example, the proceeds of the life insurance policy could be subject to tax. An ILIT can help to avoid this tax burden, as it is irrevocable, and therefore does not form part of the policyholder’s taxable estate. For more information, join us at an upcoming FREE seminar. Contact the Indianapolis estate planning attorneys of Frank & Kraft
at
(317) 684-500
for more information or to schedule an appointment. Mr. Kraft’s primary areas of expertise are estate planning and administration. He also assists clients in the areas Medicaid planning, federal taxation, corporate law, real estate, and corporate law. Latest Posts by Paul A. Kraft Estate Planning Attorney (see all)
