Life Insurance Trusts

During a previous bulletin, we discussed the downsides to naming a child (under age 19) as a direct beneficiary of a life insurance policy. Most significantly, the proceeds must be paid to the Public Guardian and Trustee’s office to hold, and then turned over to the child when he/she comes of age.

Option 1: Naming a Trustee to receive and hold proceeds

Many of our readers sent follow-up comments about the commonly utilized tool of directly naming a Trustee to hold the insurance proceeds on behalf of the child, which is done on the policy documents. Upon receiving the proceeds after the death of the insured, the named Trustee opens a trust account, and distributes cash to the guardian or pays expenses for the minor, all at the Trustee’s discretion. What remains of the funds is paid over to the child when he/she reaches age 19, with no strings attached.

We recommend that this approach be used, at a bare minimum, in all cases where beneficiaries of life insurance are minors.

If, however, clients want to postpone distribution until the child is much older than 19, this can only be achieved by using a Life Insurance Trust.

Option 2: Life Insurance Trusts

This “Cadillac” option looks like this: the client, during his/her lifetime, establishes and signs a formal Life Insurance Trust, which names a Trustee and sets out a schedule for distribution, which usually calls for the trust to end when the child is much older than 19. Due, perhaps in part, to a trend of children taking longer to become financially savvy, we find that when given the opportunity parents often elect to postpone the distribution date to age 25, or even 30, depending on the amount of money involved.

Furthermore, we are frequently drafting trusts that require the Trustee to pay lump sums to the child on certain birthdays (eg., 25% at age 25, another 25% at age 27, the balance at age 30). In this manner, parents are able to spread the amount out over a longer period, hopefully allowing their children to develop ideal money management habits over time, without turning over the whole amount at once.

Technicalities and Legalities: How Life Insurance Trusts Work

The Life Insurance Trust document is drafted by a lawyer, often at the same time as a Will, and is a stand-alone document which references the life insurance policy. The Trust document addresses issues such as successor Trustees, identifies beneficiaries, and describes the division among them, if more than one. It also includes recommended legal language to establish the relationship of the Trustee/settlor/beneficiaries, and the powers and authority of the Trustee.

Notification of the Life Insurance Trust should be given to the Life Insurance company, so that they don’t inadvertently pay out the funds to the minor or the Public Guardian and Trustee upon the death of the insured.

These Life Insurance Trusts must be established by clients during their lifetimes; they cannot be created posthumously, and without them the best that can occur is for the named Trustee to hold the funds until the beneficiary attains age 19, at which time the Trustee is then required to pay the remainder immediately to the child.