Trust vs. Will: What Happens to Your Life Insurance When You Die?

When purchasing life insurance, most people spend their time deciding how much coverage they need and who should receive the money.

But there is another important decision:

Should you name an individual as your life insurance beneficiary, or should you name a trust?

And what role does your will play?

These questions become especially important when you have minor children, grandchildren, a blended family, a beneficiary who may need help managing money, or specific instructions for how you want the life insurance proceeds used.

Understanding the difference between a will, a trust, and a life insurance beneficiary designation can help you have a more informed conversation with your insurance professional and estate-planning attorney.

What Is a Will?

A will is a legal document that provides instructions regarding how certain property in your estate should be handled after your death.

Among other things, a will may identify:

• Who should receive certain assets
• Who should serve as executor
• Who you nominate as guardian for minor children
• How certain property should be distributed
• Other instructions concerning your estate

A will generally becomes relevant after your death and typically goes through the probate process.

But here's something many life insurance clients don't realize:

Your will usually does not determine who receives your life insurance proceeds.

If your life insurance policy has a valid beneficiary designation, the insurance company generally pays the death benefit according to that designation—not according to instructions in your will.

For example, suppose your will says:

"I leave everything equally to my three children."

But your life insurance policy still names your former spouse as the beneficiary.

You should not assume the will automatically overrides the beneficiary designation. Beneficiary designations should be reviewed after major life changes and coordinated with your estate plan.

What Is a Trust?

A trust is a legal arrangement under which assets are held and managed according to the terms established in the trust document.

There are many different types of trusts, and they can serve very different purposes.

A trust generally involves several important parties:

Grantor/Settlor: The person who creates the trust.

Trustee: The individual or institution responsible for administering the trust.

Beneficiaries: The people or organizations who are entitled to receive benefits from the trust according to its terms.

Unlike simply leaving life insurance directly to an individual, a trust can establish instructions regarding how and when money is distributed.

That's one of the biggest reasons some families name a trust as the beneficiary of a life insurance policy.

What Happens If I Name My Trust as My Life Insurance Beneficiary?

This is where the distinction becomes important.

Suppose you own a $1 million life insurance policy.

Instead of naming your three children individually as beneficiaries, you designate your properly established trust as the beneficiary.

When you die and the insurer approves the claim, the death benefit is generally paid to the trustee on behalf of the trust.

The trustee then administers those proceeds according to the terms of the trust.

The life insurance company isn't normally deciding how much each child receives after it properly pays the trust. The trust document provides those instructions, and the trustee is responsible for carrying them out.

Who Controls the Life Insurance Money After Death?

This is an excellent question.

If an individual is named directly as beneficiary and is legally capable of receiving the proceeds, that beneficiary generally controls the money after the insurance company pays the claim.

If a trust is the beneficiary, the situation is different.

The trustee controls and administers the proceeds on behalf of the trust, but the trustee isn't supposed to simply do whatever he or she wants with the money.

The trustee must administer the trust according to the trust document and applicable law.

For example, a trust might instruct the trustee to:

• Pay for a child's education
• Pay certain housing or living expenses
• Provide money for health-related expenses
• Distribute a certain percentage at age 25
• Distribute another amount at age 30
• Hold the remaining funds until age 35
• Provide continuing support for a beneficiary
• Divide funds among several beneficiaries

The specific terms are established when the trust is created.

Example: Leaving $1 Million to Three Children

Suppose a mother has a $1 million life insurance policy and three children.

Option 1: Name the Children Directly

She could designate:

Child 1 – 33.33%
Child 2 – 33.33%
Child 3 – 33.34%

After an approved death claim, the insurer generally pays each beneficiary his or her designated share directly.

Once an adult beneficiary receives the money, that person generally controls what happens to it.

Option 2: Name a Trust

Instead, the mother could establish a trust and designate the trust as beneficiary.

The insurance company pays the proceeds according to the beneficiary designation, and the trustee administers the money according to the trust.

The trust might say that the children receive money gradually rather than receiving hundreds of thousands of dollars at once.

That gives the person creating the estate plan considerably more ability to establish how and when the money should benefit the beneficiaries.

Why Would Someone Put Life Insurance Into a Trust?

Naming a trust as beneficiary can be useful in certain circumstances.

One of the most common reasons is minor children.

If your child is young when you die, simply naming the child directly can create complications because a minor generally cannot personally manage a large life insurance payment.

A properly drafted trust can instead provide instructions for the trustee to manage those funds for the child's benefit.

Trusts may also be considered when:

• You have young children or grandchildren
• You have a blended family
• You want distributions made gradually
• You are concerned about a beneficiary's ability to manage a large amount of money
• You want money reserved for education or other purposes
• You have a beneficiary with special needs
• You want greater control over how inherited assets are administered
• Your estate-planning attorney recommends a trust for tax or estate-planning purposes

Different objectives may require very different types of trusts.

Is Life Insurance Taxed When the Beneficiary Is a Trust?

This is another area where there is a lot of confusion.

Federal income tax

Generally, life insurance death benefits paid because of the insured's death are not included in the beneficiary's gross income for federal income-tax purposes.

Naming a trust as beneficiary does not automatically mean that the entire death benefit becomes taxable income.

However, exceptions and special circumstances can apply.

For example, interest paid by an insurance company in addition to the death benefit may be taxable.

Estate taxes are a different issue

People sometimes hear that "life insurance is tax-free" and assume that means life insurance can never affect estate taxes.

That's not necessarily true.

Whether life insurance proceeds are included in the insured's taxable estate can depend on factors such as who owned the policy, what rights the insured retained over the policy, how the trust was structured, and when ownership changes occurred.

This is one reason clients with substantial estates should coordinate life insurance planning with an experienced estate-planning attorney and tax professional.

Naming a Trust as Beneficiary Is Different From Having the Trust Own the Policy

This distinction is extremely important.

A trust being the beneficiary of a life insurance policy is not necessarily the same thing as a trust owning the life insurance policy.

For example:

Scenario A:
Kristine owns her life insurance policy personally, but her trust is named beneficiary.

Scenario B:
A properly structured trust owns the life insurance policy and is also the beneficiary.

Those arrangements can have very different legal, tax, estate-planning, and administrative consequences.

An insurance agent can help clients understand the insurance policy and beneficiary options, but an estate-planning attorney and tax professional should determine the appropriate legal and tax structure.

What Is an Irrevocable Life Insurance Trust?

Some clients may hear the term ILIT, which stands for Irrevocable Life Insurance Trust.

An ILIT is a specialized estate-planning trust that may own life insurance and is sometimes used as part of more sophisticated estate planning.

It is very different from simply creating a basic revocable living trust and naming it beneficiary.

ILITs have specific legal and tax considerations and should be established with an attorney experienced in estate and trust planning.

Do not transfer an existing life insurance policy into a trust simply because you heard it could save taxes. Ownership changes can have significant consequences.

Can the Trustee Take the Life Insurance Money?

A trustee generally has control over the trust assets for purposes of administering the trust, but that does not mean the trustee owns the money personally.

The trustee has legal duties and must follow the trust's terms and applicable law.

That's why choosing the trustee is such an important decision.

Depending upon the situation, someone might select:

• A trusted family member
• A close friend
• An attorney or other qualified professional
• A bank or professional trust company
• Co-trustees

The person creating the trust should carefully consider whether the proposed trustee has the judgment, financial responsibility, willingness, and ability to carry out those responsibilities.

What Happens If You Don't Name a Beneficiary?

This is another reason to periodically review your life insurance.

If there is no valid living beneficiary when the insured dies, the policy's terms determine where the proceeds are payable. In some circumstances, proceeds may become payable to the insured's estate.

If proceeds become part of the estate, probate and creditor considerations can become more important.

That's very different from having a properly designated beneficiary who can receive proceeds directly under the policy.

Don't Set Up Your Life Insurance and Forget About It

Life changes.

Your beneficiary designations should be reviewed periodically, especially following:

• Marriage
• Divorce
• Birth or adoption of a child
• Birth of grandchildren
• Death of a beneficiary
• Remarriage
• Creation or amendment of a trust
• Significant increase in wealth
• Purchase or sale of a business
• Major changes in family circumstances

Having the right amount of life insurance is important.

Making sure the right person or trust receives it can be just as important.

Life Insurance & Beneficiary Reviews in Georgia

At Jones Group Insurance Services, we help individuals and families throughout Georgia evaluate their life insurance needs and review their beneficiary designations.

Your insurance agent does not replace an estate-planning attorney or tax advisor. However, we can help make sure you understand your life insurance policy, coverage amount, ownership and beneficiary designations so that you can coordinate those decisions with your overall estate plan.

We serve clients throughout Georgia, including Atlanta, Marietta, Acworth, Kennesaw, Woodstock, Canton, Smyrna, East Cobb, Cobb County, Paulding County and surrounding communities.

Jones Group Insurance Services
770-933-7929
3459 Acworth Due West Rd NW, Suite 319
Acworth, GA 30101