Understanding The Role Of A Trustee In Term Insurance: A Comprehensive Guide

A trustee is a third party, often a bank, that is legally responsible for managing a trust and distributing its assets on behalf of a grantor. In the context of insurance, a trustee manages the assets in the trust according to the terms of the trust agreement. Trustees are often used to manage life insurance trusts, which are created by a policy owner (settlor) to ensure proceeds are distributed to the beneficiaries of the trust in a way that meets the settlor's goals. Life insurance trusts are often exempt from estate tax, meaning that a death benefit from a life insurance policy in a trust can provide a higher amount to beneficiaries than it would outside of a trust.

Characteristics of a Trustee in Term Insurance

Irrevocable vs. revocable life insurance trusts

A trustee is a third party who manages the assets in a trust. Now, let's look at the differences between irrevocable and revocable life insurance trusts.

Irrevocable Life Insurance Trusts (ILIT)

Irrevocable life insurance trusts are a type of trust that holds and manages life insurance policies. The trust is "irrevocable" in the sense that it can’t be changed or canceled after it’s been set up.

You won’t be able to change or revoke an irrevocable trust once it’s in place. If you’re seeking flexibility, a revocable trust may be the better choice.

By establishing an irrevocable trust (instead of a revocable one), you can potentially avoid estate taxes and any claims from creditors, ultimately leaving a larger inheritance for your life insurance trust beneficiaries.

Revocable Life Insurance Trusts (RLIT)

A revocable life insurance trust (RLIT) is a type of trust that, unlike an ILIT, can be changed or canceled by the grantor at any time. RLITs are also known as living trusts.

With an RLIT, you retain control over the life insurance policy and can change the trust’s terms as you see fit. The trust becomes irrevocable after your death, or if you become incapacitated.

RLITs do not offer the same tax advantages as ILITs. Since the grantor retains control over the life insurance policy, it remains part of their estate and is subject to estate taxes upon their death.

The biggest difference between irrevocable and revocable life insurance trusts is that the former cannot be changed, altered, or revoked once it has been set up. On the other hand, the latter can be changed, altered, or revoked at any time.

Irrevocable life insurance trusts are shielded from creditors, whereas revocable life insurance trusts are not.

Irrevocable life insurance trusts are not subject to estate tax, whereas revocable life insurance trusts could be subject to it.

Irrevocable life insurance trusts are ideal for those wanting to reduce estate tax or shield assets from creditors. On the other hand, revocable life insurance trusts are ideal for growing families whose needs may change in the future.

Benefits of a life insurance trust

A trustee is a third party who is legally responsible for managing a trust and distributing its assets on behalf of a grantor. Trustees are often banks. In the context of insurance, many people use trustees to manage life insurance trusts.

A life insurance trust is a trust created by a policy owner (settlor) to ensure proceeds are distributed to the beneficiaries of the trust in a way that meets the settlor’s goals. Here are some benefits of a life insurance trust:

Avoiding probate

Life insurance trusts can help beneficiaries avoid probate fees, as the trust is separate from the deceased policy owner’s estate, which may be probated.

Control of distribution

Life insurance trusts allow the settlor to control the distribution of proceeds to beneficiaries. This is especially important if the beneficiary is a minor, as it eliminates the need for a court-appointed guardian of property that can receive insurance proceeds.

Protection from creditors

Life insurance trusts offer protection from creditors because the proceeds do not form part of the estate of the settlor (the policy owner who has died).

Tax benefits

Life insurance trusts can help reduce federal estate tax. With an irrevocable insurance trust, the death benefit isn’t included in the grantor’s estate and isn’t subject to estate tax unless the grantor dies within the first three years of the life insurance policy.

Maintaining privacy

Where privacy is important, a will may not be the best place to create an insurance trust because if the will is probated, it will become a public record.

Protecting beneficiaries

Life insurance trusts can be used in a divorce or separation situation where having a trustee disburse the insurance proceeds may be better than having an ex-spouse do that work. They can also help ensure that a beneficiary who is eligible to receive provincial government benefits will be able to keep those government benefits.

Drawbacks of a life insurance trust

A trustee is a person who manages assets for beneficiaries. A life insurance trust is a legal arrangement that involves a trustee managing assets for beneficiaries. Here are some drawbacks of a life insurance trust:

High fees

The complexity of setting up and managing a life insurance trust can result in high legal fees.

Lack of control

Once funds are placed in an irrevocable life insurance trust, the grantor loses control over how they are used and distributed. It is crucial to set up the trust in a way that ensures it can continue paying premiums. This drawback does not apply to revocable life insurance trusts, which can be amended at any time.

Three-year lookback period

If the grantor dies within three years of setting up an irrevocable insurance trust, it may be included in their estate and therefore subject to taxes. This is known as the three-year rule.

Tax implications

While proceeds from a life insurance policy are generally income-tax-free for beneficiaries, this is not the case when the beneficiary is a trust. Trusts are not considered individuals, so proceeds paid to trusts are generally subject to estate tax.

Complexity and cost of setup

The process of setting up a life insurance trust can be complex and require the assistance of an estate planning attorney. This can result in additional costs.

Loss of flexibility

Irrevocable life insurance trusts cannot be changed, altered, or revoked once they are set up. This lack of flexibility may be a drawback for those who desire the ability to make changes to their trust in the future.

How to fund a trust with life insurance

A trustee is a third party, often a bank, that is legally responsible for managing a trust and distributing its assets on behalf of a grantor. Trustees are often used to manage life insurance trusts, where a life insurance policy is the primary asset of the trust.

• Determine the type of trust: Choose between an irrevocable life insurance trust (ILIT) and a revocable life insurance trust (RLIT). ILITs offer more tax benefits but cannot be changed or revoked, while RLITs are more flexible but offer fewer tax advantages.
• Choose the life insurance trust beneficiaries: Decide which family members or heirs will benefit from the policy and how much each will receive.
• Calculate the amount of insurance needed: Consider your family's current and future finances, including educational needs, estate taxes, funeral costs, etc.
• Select the type of life insurance: Permanent life insurance policies are ideal but term life insurance is more affordable.
• Purchase the life insurance: Shop around for quotes and consider policy fees and growth rates.
• Transfer ownership of the policy to the trust: Sign a form from the insurance company and provide information about the trust, possibly with the help of an estate planning attorney.

Funding a trust with life insurance offers several benefits, including tax advantages, asset protection, and avoiding probate. However, there are also drawbacks, such as high fees and lack of control over irrevocable trusts.

Who can be a trustee

A trustee is a third party who is legally responsible for managing a trust and distributing its assets on behalf of a grantor. Trustees are often banks. In the context of insurance, many people use trustees to manage life insurance trusts.

There are three parties to an insurance trust: the settlor (who is also the policy owner), the trustee, and the beneficiary. The settlor names a trustee and provides them with powers about what can be done with the proceeds and how they are to be distributed. There can be more than one trustee appointed to a trust.

The trustee's role is to manage the assets in the trust according to the terms of the trust agreement. Trustees bear a fiduciary responsibility to the beneficiaries of a trust. They are required to manage the trust assets in accordance with the wishes of the beneficiaries. This is an important concept to grasp. The desires of the beneficiaries are paramount, not the desires of the individual who established the trust.

When it comes to choosing a trustee, there are a few options. People who establish trusts funded by life insurance typically first look to a friend or family member to serve as a trustee. However, such individuals often lack knowledge about the prudent management of life insurance. The other popular choice is a trusted advisor, such as a financial advisor, accountant, or lawyer.

However, it is important to note that there is no guarantee that a trusted advisor will be well-versed in the intricacies of trust management. Therefore, it is crucial to carefully consider the qualifications and expertise of potential trustees to ensure they can fulfil their fiduciary responsibilities effectively.

Frequently asked questions