Should Life Insurance Be in a Trust?

How Life Insurance Works When Owned by a Trust

When a trust owns a life insurance policy, the grantor is the person establishing the trust and usually the person whose life is insured. For policies owned by an irrevocable trust, the grantor and trustee cannot be the same person. When the grantor dies, the trustee will distribute the policy proceeds to the beneficiaries outright or in a subtrust pursuant to the terms of the document.

Life Insurance Trusts are a Smart Choice for Those With Minor Children

Parents and grandparents who want to name a minor as a beneficiary should transfer their policy to a trust for the child’s benefit to avoid court intervention. A minor cannot inherit property outright, so if funds are left directly to the child, a Surrogate’s Court guardianship would be required to appoint a guardian of the minor’s property. This administrative headache can be avoided if the parent or grandparent’s trust directs that the minor inherit via subtrust. The subtrust can be managed by a trustee of the grantor’s choosing until beneficiaries reach a stated age.

Regardless of age, it can be a good idea for beneficiaries to receive policy proceeds in a subtrust. The subtrust contents are typically shielded from the beneficiary’s creditors, and the value is not included in the beneficiary’s taxable estate upon their own death.

Estate Tax Benefits Are Possible With Irrevocable Life Insurance Trusts

For individuals with taxable estates (in 2026, $7.35 million per person for New York and $15 million per person for the Federal), an irrevocable life insurance trust can exclude the proceeds from being included in the taxable estate. One caveat, the policies will only be excluded if they were transferred at least three years before death. This can reduce estate taxes, provide liquidity to cover estate expenses, and help avoid the sale of illiquid assets to pay taxes due within nine months of death.

Medicaid Asset Protection Trusts and How They Can Impact Life Insurance Planning

If the goal of changing the policy ownership to a trust is to become Medicaid eligible, an irrevocable Medicaid asset protection trust will be the best option. When applying for nursing home Medicaid, life insurance with a cash surrender value of $1,500 or less is exempt and not counted toward Medicaid’s asset limit. For larger policies, if the policy is transferred to an irrevocable Medicaid asset protection trust at least five years before applying, it is protected from being used to pay for nursing home care. For Medicaid home care services, the protection begins the month after transfer.

Consider Speaking With an Estate Planning Lawyer About Your Life Insurance

Reviewing your planning with an attorney is the best way to determine how to protect your life insurance policy for you and for your intended beneficiaries. With proper planning, the life insurance can be preserved as it was meant to be.

By Britt Burner, Esq. & Erin Cullen Esq.

Britt Burner, Esq. is a Managing Partner at Burner Prudenti Law, P.C. focusing her practice areas on Estate Planning and Elder Law. Erin Cullen is an Associate Attorney at Burner Prudenti Law P.C. Our firm serves clients from New York City to the east end of Long Island with offices located in East Setauket, Westhampton Beach, Manhattan, and East Hampton.