8.4 Life Insurance Trusts

• Library: A Lawyer's Guide to Estate Planning: Fundamentals for the Legal Practitioner (ABA) (2018 Ed.)

8.4 Life Insurance Trusts

8.41 Revocable Life Insurance Trusts

A revocable life insurance trust is a useful estate planning tool when estate tax savings are not a consideration. In a typical situation, the insured has purchased life insurance to provide for the financial needs of the surviving spouse and/or minor children. In either situation, the insured is the owner of the insurance, and the proceeds will be taxable in the insured's estate for federal estate tax purposes.²²

The insured may choose not to have the life insurance proceeds payable directly to the beneficiary for various reasons. For example, if the insurance is intended to provide for the support and education of minor children, the insured may be unwilling for the insurance to be payable to the children's guardian. The guardian may not be well versed in financial matters, or in many cases the guardian may be an ex-spouse with whose judgment the insured is uncomfortable. Even if the guardian is otherwise competent to handle financial and investment matters on behalf of the children, a guardianship must terminate on the age of majority, which is age 18.

Few parents want their children to receive a large inheritance at 18 years of age. They are more comfortable with a trustee's investing the insurance proceeds for the benefit of the children and paying income or principal as needed for the children's support and education. When the children reach a specified age, such as 25 or 30 years, the trust can terminate and be paid outright to the children.

If the life insurance proceeds are intended to provide for the financial needs of a surviving spouse, a trust may still be a good choice. The financial expertise of a trustee may be invaluable. Even if the insured feels comfortable with the surviving spouse's handling of financial matters, a trust arrangement may be useful to care for the survivor's financial needs later in life, particularly during periods of disability. Additionally, a trust often lessens the probate costs that the survivor's estate otherwise will incur. Finally, a trust prevents the insurance proceeds from being subject to the inheritance rights of a future spouse, should the survivor remarry.

Planning Pointer 3

An inter vivos revocable trust is the preferable type of trust to use; however, a testamentary trust may also be used. An inter vivos trust is executed by both the settlor and the trustee; thus, the insured knows in advance that the trustee will serve as trustee. A testamentary trustee often does not know it is named as trustee and may refuse to serve when notified of the trusteeship after the decedent's death, for example, if the trust contains provisions with which it is uncomfortable. The inter vivos trust avoids this dilemma because the trustee can review the trust document and sign it during the settlor's lifetime. Any problem with the trust then can be resolved. The trust document in Chapter 15, at 15.3, is a revocable life insurance trust drafted to save estate tax through the proper use of the marital deduction.

Caution: A revocable trust becomes irrevocable at the death of the settlor. Although the terms of the trust may vary widely, special care should be taken if the trust is to continue for the lifetime of the beneficiary. In that situation the trust instrument must consider the ultimate beneficiaries and specify when and how they are to receive their shares. Normally, if the life beneficiary is someone other than the surviving spouse, he or she should not be granted a general power of appointment—that is, a power that can be exercised in favor of the holder (donee) of the power, his or her estate, or the creditors of either. This will result in the trust's being taxed in the life beneficiary's estate. A...