Having life insurance proceeds go directly to a spouse or child may create more problems than it can solve. You do not know when your death will make available a sizable insurance check for your young bride or young child. It may be best to have protective measures in place to offer some control over the funds. By using an Irrevocable Life Insurance Trust, we can accomplish that goal. For this article, we will use the term ILIT when referring to an irrevocable life insurance trust.
What is an Irrevocable Life Insurance Trust?
An ILIT is an irrevocable trust that is created to own and be the beneficiary of a life insurance policy on the trust maker’s life. The death proceeds of life insurance held in an ILIT are not included in the estate of the insured or the insured’s spouse if properly drafted. By the use of an ILIT you can control who gets the funds and at what age. Remember, we do not know when you or your spouse will die. A properly drafted ILIT can offer a defined payout at a time appropriate to the needs and maturity of the beneficiaries. Here are some thoughts to consider.
Minor Children. If money goes to minor children, they may be too young to legally accept the funds without a guardian. Who will control the money and how will the funds be used? What if a child becomes incapacitated before he or she receives the money? What if there is a second marriage involved with his, hers and our children?
Adult Children. If you leave a lump sum proceeds to an adult child, can he or she handle the funds? A large amount of money could destroy a young adult’s work ethic and perhaps his or her life. A lump-sum payment to your adult child is also exposed to his or her spouse and creditors. Even when adult children are responsible, a misfortune such as a lawsuit, bankruptcy, divorce, or death may put the policy proceeds at risk.
Spouse. If your life insurance names your spouse as a lump-sum beneficiary, all decisions will belong to the spouse. If you want the money to go to your spouse and then to your children, what happens if your spouse remarries? If your spouse remarries and then dies before your “replacement,” the second spouse may have a right to all of the money. If your spouse leaves the proceeds to your children by will, the new spouse may have elective rights that will transfer the funds to the new spouse. What if your surviving spouse does not know how to handle money or becomes incapacitated?
In an ILIT, you have one opportunity to create the blueprint as to what happens to the funds and to whom the funds shall pass. You have initial control but you do not get the luxury of changing your mind as to the provisions later on during your life. This normally applies to a large policy. It may be wise to consider placing the policy and subsequently the proceeds into an ILIT. You can insure that the proceeds will accomplish the purpose you intended when you created the policy.