How to List Beneficiaries for Life Insurance While Having a Trust

Because most jurisdictions shield life insurance policies from creditors, the majority of buyer questions stem from the tax treatment of ownership and beneficiary arrangements.

When it comes to life insurance proceeds, it's a bit more complicated because there are two types of taxes to consider: ordinary income taxes (for the beneficiary) and federal estate taxes (on the estate tax return of the deceased).

If your spouse is the beneficiary of your life insurance policy, there's usually no problem; assets pass tax-free between husbands and wives regardless of the amount (as long as the spouse is a U.S. citizen).

If your estate is significant (over $2 million), you may want to consider transferring ownership of your life insurance policy to an irrevocable life insurance trust to avoid paying taxes on the surviving spouse's death.

Why? The proceeds of the death benefit payout will not be included in your taxable estate, which might be taxed up to 40% if you own the policy through an irrevocable trust. The exclusion does not apply to revocable trusts. If the insurance is new, immediately name the trust as the owner. You can transfer ownership of the policy to the trust if it already exists.

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KEY TAKEAWAYS 

• If you have a significant estate (more than $2 million), you should think about putting your life insurance policy in an irrevocable life insurance trust.
• The proceeds of the death benefit payout will not be included in your taxable estate, which might be taxed up to 40% if you own the policy through an irrevocable trust.
• In most circumstances, naming individual beneficiaries on life insurance plans is preferable to appointing a trust as beneficiary.

However, you should be aware that, in order to prevent deathbed transfers, the government requires you to survive the transfer for three years or your estate would be taxed regardless.

In addition, if the cash value of the insurance you'd get if you cashed it in now rather than when you die is more than $15,000 (as of 2019), the transfer may exhaust some of your gift and estate tax exemptions.

Beneficiaries on Life Insurance Policies 

In most circumstances, naming individual beneficiaries on life insurance policies is preferable to appointing a trust as beneficiary. If your beneficiaries have creditor difficulties, mental health concerns, or can't be trusted with huge sums of money, or if their primary beneficiaries are kids or have drug problems, or if there are other unique circumstances, naming the trust as beneficiary may be a preferable option.

If a spouse is specified as the beneficiary for federal tax purposes, life insurance earnings received upon the death of the insured are normally tax-free (if paid in a lump sum).

Because trusts are not treated as people, life insurance proceeds paid to them are usually subject to estate tax. Furthermore, the proceeds payable to a trust may not be eligible for the inheritance tax exemption that some jurisdictions allow for insurance disbursed to a named beneficiary. A greater tax may be due in some states.