What is an irrevocable life insurance trust?
Understanding a life insurance trust
People often buy life insurance to help protect their children, but children under 18 typically cannot be named as beneficiaries of a life insurance policy. Young children generally must receive the money through a third party like a legal guardian.
For this reason, parents may place their life insurance policy in a trust, which can receive money on behalf of the children. A trust “holds” the property (which may include life insurance) of the “trustor”—in this case, the parents—so it can be distributed to trust beneficiaries—in this case, the children. The person who manages the distribution of the property to beneficiaries is the “trustee.” This may be the parents’ designated guardian for the children or a third party like an attorney.
Why do parents choose to do this? Typically, to help protect the interests of their children and to make the money (in this case from life insurance) available for the care of children as quickly as possible. Sometimes when parents die, the legal process for recognizing a legal guardian delays children from getting the benefit of the life insurance money intended for their care. However, a named trustee can administer funds immediately.
You decide the terms of the trust, including how life insurance money is paid to your children. For example, your trust may require that while children are under 18, money will be paid out to the guardian to cover their clothing, food, and medical expenses, but that, when they turn 18, the children get a monthly living allowance directly from the trust.
Some trusts are revocable
If the parents put their life insurance in a trust that is “revocable,” that means the trust may be ended or changed. In fact, it can be changed more than once. Why would someone want to change a trust? Imagine parents who first decide that all the life insurance money can go directly to a child at the age of 18, but then later change their minds and decide that the benefits should be paid only toward a child’s college tuition. A revocable trust gives them that flexibility.
Some trusts are irrevocable
However, when parents want to help make sure that no one is able to change the terms of the trust and how the money is distributed to their children, they often choose to put their policy in what is known as an “irrevocable” life insurance trust. The term “irrevocable” means that the terms of the trust are permanent and cannot be changed.
How an irrevocable life insurance trust works
To create an irrevocable life insurance trust, you will likely need the help of an estate lawyer. Once the trust is created, you could either transfer the ownership of your current life insurance policy to the trust or purchase a new life insurance policy in the trust’s name.
Advantages of an irrevocable life insurance trust
If a trust is irrevocable, it can be very difficult for your trustee to make any changes to the terms of the trust. In that sense, it helps a parent guard against the possible misuse of funds by the trustee or caretakers.
Disadvantages of an irrevocable life insurance trust
It often costs money to set up an irrevocable trust, so do a little research to see if you think it’s worth the cost. It may also affect your tax returns. Most of all, remember that the terms of the trust may not be changeable once you give it ownership of your life insurance policy. Be sure about your decisions before you decide to go with an irrevocable trust.
If you want to help make sure that your children would receive life insurance money without delay after you pass away, and if you want to make sure no one can change how that money is used, an irrevocable life insurance trust may be worth looking into. But remember, it’s important to understand what it means. So don’t be afraid to ask questions.