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How and Why to Set up a Life Insurance Trust for Your Children

Set up a Life Insurance Trust for Your Children

For those with children and grandchildren, the safety and future of their children and grandchildren is always a priority. Setting up a life insurance trust for them is one of the best ways to control, and take care of, your money so that your children will have a secure future in your absence.  

Unfortunately, life is not under our control, and we cannot determine or assure what will happen in the future. What you can control is the way you manage and allocate your money for your children’s future. 

If you are a grandparent who has purchased or wants to purchase life insurance for your grandchildren, this information is also of interest to you.

Setting Up a Trust

If you have purchased life insurance, it is also a good idea to set up a trust that will allow you to determine how the money will be used for the welfare of your children. 

To open a life insurance trust for your children, you should take into account certain factors and initiate a number of procedures:

      • Hire a lawyer specialized in inheritances.
      • Consult with your accountant, financial planner and attorney to address tax issues.
      • Choosing a trustee and backup trustee.
      • Change beneficiaries from your life insurance policy to your child’s or grandchild’s trust.
      • Have the necessary paperwork required for the bank when you open a trust account.

A trust has monetary benefits for the beneficiaries and has one key advantage: you can choose how these assets are managed and used by appointing a trustee to oversee the process instead of naming your children as beneficiaries. 

In the event of your death, the trustee will administer the money as you have determined in your own trust rules. 

Relevance of Opening a Trust

Generally, life insurance policies name your children as beneficiaries. The disadvantage of this is that if your children are minors in the event of death, the insurance company is not authorized to pay benefits until a legal guardian has been appointed, which requires time and money.

This can be remedied by appointing a custodian to administer your child’s or grandchildren’s estate under the Uniform Transfers to Minors Act (UTMA). Thus, if your children or grandchildren are still minors at the time of your death, the custodian is authorized to administer the money until they reach the age of majority and can receive the remaining money. 

However, this is not very convenient as most parents or grandparents are not comfortable with the idea of their children or grandchildren receiving a large amount of money at the age of 18 – 21, as this could leave them financially vulnerable. 

By using a trust, you will have the flexibility that a UTMA transfer is unlikely to provide. With a trust, you can precisely determine the destination of your money, for example, and can direct it specifically to your children’s education until a set time where they will later receive an amount at a certain age to invest in a house or for their health.

Types of Trusts

Trusts can be revocable or irrevocable. As its name suggests, a revocable trust can be modified after its creation during its lifetime and is much easier to establish. On the other hand, an irrevocable trust cannot be modified once it is created, and if the creator wishes to modify it, it is very difficult to do so. An irrevocable trust has tax benefits for the beneficiaries that revocable trusts do not offer. 

Wealthy individuals are the ones who generally open an irrevocable trust to protect heirs from taxes that the federal government and some states levy on estates once transferred to heirs. 

Federal estate taxes apply to estates worth more than $11.4 million per individual or $22.8 million per couple. These amounts usually change annually depending on the rate of inflation. Generally, estates are of sufficient value to be unaffected by federal estate taxes. 

Special Needs Trust

A special needs trust is a trust for those who have a disabled child or grandchild.

Generally, disabled persons cannot have more than $2,000 in assets in their name while qualifying for government assistance programs. 

However, with a special needs trust, you are able to retain life insurance money without being disqualified from benefiting from federal and state health insurance programs. 

Benefits of Revocable Trusts

One of the benefits of a revocable trust, as mentioned above, is that it can be changed at any time. The grantor can be named as trustee and beneficiary of the trust. Once the children are older, they can return to the trust and name a new beneficiary. The trust can be modified as many times as you require. However, these changes can be costly as it requires legal fees.

Another benefit is that, when the grantor dies, the trust information is kept out of probate, and the trust stipulations are kept within the family to be handled privately.

Benefits of Irrevocable Trusts

An irrevocable life insurance trust is used for estate tax protection purposes. Thus the person who creates an irrevocable trust will be benefiting his or her family by protecting their assets. 

Unlike a revocable trust, instead of naming a trustee and beneficiary, the grantor must designate a separate trustee and must make sure that the person chosen is someone he or she trusts and feels comfortable giving the property and the ability to control the assets to this person.

One of the benefits of opening an irrevocable trust is that it avoids gift tax consequences since the grantor’s contributions are considered gifts to the beneficiaries. 

It can also help protect the benefits of a trust beneficiary who receives government assistance such as social security disability income or some other government organization. The trustee can control how the trust contributions will be used to not interfere with the beneficiary’s eligibility to receive such government benefits. 

The most significant disadvantage of this type of trust is that no changes can be made once the trust has been created and ownership of the asset(s) placed in the trust is lost. 

It is important to consult with financial professionals who can guide you on which trust is ideal for you and your family to make the right decisions. You should also have a lawyer who can help you determine and stipulate the rules to be followed in the event that you are unable to do so. 

Evaluate the disadvantages and advantages of each one and adjust it to your personal and family needs to make the best decision. The most important thing is to guarantee and safeguard the future of your children or grandchildren. 

Featured Image: Twenty20

About the author: Matthew is a financial writer, essayist, and editor of several publications. He writes books for fun and travels as a challenge to see every country.

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