Estate Planning: How To Utilize Life insurance And Trusts

Death benefits payable from a life insurance policy on the death of the insured can be considerable.

Such benefits can either be paid directly to one or more individual beneficiaries or be paid to a trust administered for their benefit.

A trust can own and/or be the death beneficiary on a life insurance policy. Unlike retirement plans, there is no income tax disadvantage to naming a trust as the death beneficiary of a life insurance policy.

Moreover, for very high net worth persons, having an irrevocable life insurance trust purchase and own the life insurance policy is a way to keep a considerable asset outside of their estate and so minimize federal estate taxes.

Nowadays, however, with the estate tax threshold at around 11.2 million dollars far fewer persons are concerned with estate tax minimization.

Nonetheless, naming a trust, including a revocable living trust, as a death beneficiary on a life insurance policy offers other advantages: It allows for more contingency planning in the event that the primary death beneficiary does not survive to inherit; it allows for cash to fund a trust that may otherwise be short on cash; it allows for the death benefits to be held in further trust in order to protect such benefits and/or the beneficiary; and it allows for the management of the death benefits by a trustee.

Naming alternative death beneficiaries, and changing one's death beneficiaries, through the life insurance company's own change of death beneficiary forms does not compare favorably to naming a trust as the death beneficiary.

The change of death beneficiary form provides very limited choices when it comes to naming secondary alternative death beneficiaries. That is, what happens when a first tier alternative death beneficiary does not survive the insured.

With a trust, however, a tailored plan of distribution to secondary alternative beneficiaries is possible. The trustee receives the death benefit proceeds and follows the instructions in the trust as to how such proceeds are to be administered in any eventuality.

Life insurance policies are also a good way to ensure that the trust has adequate funds to pay for debts, administration expenses and to fund shares. This will allow other non-cash assets not to be sold at unfavorable prices and to equalize inheritances when some beneficiaries receive cash and other beneficiaries receive non cash assets (like real property and stocks).

Trusts also can be drafted and administered to protect the beneficiaries, who would otherwise inherit directly from the life insurance policy, from claims by judgment creditors.

When beneficiaries receive insurance proceeds outright such money becomes subject to collections by their own judgment creditor. Inside a trust the money remains safe from the beneficiaries' creditors.

The trustee (someone other than the beneficiary) can be authorized to make distributions to or for the benefit of the beneficiary.

In addition, the trustee can administer the death benefits according to the settlor's instructions. Otherwise, with an outright distribution, the money may be used in ways that the settlor does not approve. Such concern is relevant when the beneficiary does not manage their own money well, makes poor choices, or is subject to control by other persons.

Lastly, naming a trust as the owner of a life insurance policy can be accomplished by declaring the transfer of the life insurance policy within the trust itself.

In Dudek v. Dudek (2019) 34 CA5th 154, California's Fourth District Court of Appeal, addressed whether the failure of the life insurance owner to properly execute the life insurance company's own legal forms resulted in a failed attempt to transfer the ownership in the life insurance policy.

The Dudek appellate court ruled that language of conveyance included in a deceased insured's trust was sufficient in itself to convey ownership of a life insurance policy.

In sum, naming a trust as death beneficiary may be appropriate for a variety of non-tax reasons such as who inherits if an alternative beneficiary fails to survive, equalizing out inheritances, and protecting beneficiaries' inheritances.

Dennis A. Fordham, attorney, is a State Bar-Certified Specialist in estate planning, probate and trust law. His office is at 870 S. Main St., Lakeport, Calif. He can be reached at [email protected] and 707-263-3235.