Life Insurance Trusts

In this type of trust, a life insurance policy or multiple policies are owned by a trust. When the insured person dies, the trustee invests the insurance proceeds and then administers the trust on behalf of the beneficiaries. It is advantageous for the trustee of a trust to purchase the life insurance on the life of the insured, typically the grantor. A life insurance trust is typically irrevocable.

There are two categories of life insurance trusts:
  • Funded―The trust owns the insurance contract(s) AND income-producing assets, which are normally used to pay part or all of the policy premiums.
  • Unfunded―Any insurance policies owned by the trust are funded by grantor gifts.

Typically, in cases where the insured is married, beneficiaries will include the non-insured spouse and children, if applicable. Policies can be set up to feature survivorship (also known as “second to die”) clauses in which they only pay once both spouses die, leaving children as the sole beneficiaries.


When a life policy is funded when the insured dies, its proceeds are utilized to purchase assets from the estate in order to provide the estate with adequate liquidity for any estate taxes due. In South Dakota trusts have the lowest premium tax.

Cautionary notes
  • Funded life insurance trusts are often less attractive because they are subject to the gift tax (when transferring income-producing assets to the trust) and the grantor trust income tax.
  • The Internal Revenue Service imposes a three-year window restriction in cases where the insured transfers an existing policy to a life insurance trust. If the insured dies within three years of the transfer, the insurance proceeds will still be subject to estate taxes.
  • If the policy is owned by the insured and the proceeds exceed a certain amount, they may be subject to estate taxes. Sometimes the insured will designate a beneficiary such as a spouse or child as the owner of the policy to avoid estate taxes, but this is not usually recommended.
  • Unfunded insurance trusts that use the annual exclusion gift exemption become subject to Crummey letters. A Crummey letter is sent to each beneficiary of an insurance trust offering the recipient a window of time (often 30 days) to take immediate control of the gift. (The control offered only applies to the current gift – by assumption, an amount no greater than the annual exclusion amount – not the entire trust.) If the recipient fails to do so during that window, the gift becomes part of the trust, and is subject to the trust’s distribution conditions. By giving the beneficiary the opportunity to receive the funds outside of the trust, the gift is deemed to be a current interest, subjecting it to the annual gift exclusion.

Descriptions of trusts are intended to be informational and are not specific recommendations. Contact a trust officer at Sterling Trustees for more detailed information on what would be best suited to your circumstances.


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