When you hear the word “trust” in reference to a life insurance policy, you might think of the stereotype of “trust fund babies.” You might think that trusts are only for the incredibly wealthy. However, anyone with a child under the age of 18 can benefit from setting up a trust as part of his or her life insurance policy.
What Is a Trust?
A trust is a financial arrangement between three people – a trustor, trustee, and beneficiary – that is put into place to support the beneficiary in the event that the trustor passes away. In simpler terms, trusts are put into effect to hold money for your children. One of the huge benefits of having a trust is the fact that you can decide how you want your assets to be spent and managed. In addition, this policy saves your children from having to deal with estate taxation, a large chunk of money that would otherwise be deducted from your assets.
Choosing a Trustee
A child under the age of 18 may not know how to save and spend such a large sum of money; this is why trustees are put into place. This person, who may or may not also be their guardian in the case of your passing, will manage the money, making sure it is being spent as you wished. With a trust policy, you get to choose who this trustee is; a trusted relative or lifelong friend is often the best option.
An Important Exception
One important rule you need to abide by is what is considered the three-year look-back rule. Under this, after you fund your trust, you need to outlive this transfer by at least three years or the Internal Revenue Service will return these death benefits to your estate. This will lead to estate taxation, the unwanted expense that caused you to put this trust into effect in the first place. It’s better to set up a trust sooner rather than later for this reason. In case you get sick in the next few years, you should be prepared.
Trusts vs. Beneficiaries
If you have a trust put into place, your dependents won’t have to deal with litigations following your death. If you die while your kids are still minors without a trust in place, your life insurance won’t give anything to your kids until a court-appointed guardian steps in. This could take a long time, which would give them no access to your assets during this duration. In addition, it can cost a good chunk of money, as it involves the cost for an attorney and court proceedings.
You’re in Control, Even Post-Mortem
Rather than your child getting a lump sum of the money, a trust allows you to arrange how you want the money to be spent. A minor under the age of 18 or 21 – depending on the state – may not know what to do with that much money. With a trust, you can put aside a certain amount for college tuition, living conditions, or other important expenses. Giving a child access to so much money at once could do more harm than good, even if you believe your child is responsible. With a trust, you can even give your child certain sums of money on landmark events, like your child’s 30th birthday or wedding day.
What Are the Different Types of Trusts?
Revocable: This type of trust allows you to change or terminate the policy during your lifetime. Most people investing in a trust opt for this plan.
Irrevocable: This form of trust cannot be undone. Wealthy parents often use this kind of trust because it protects their children from estate taxes. (Estate taxes are what the government charges on property when it’s passed down to its next heir.) With an irrevocable trust, property is usually not considered part of the estate, making it exempt from taxes.
Special Needs Trust: This type is a good option for parents of a child with special needs. This trust holds your assets for your kid, but still makes him or her eligible for state and federal health insurance and Medicaid. Without this trust, your child would lose his or her access to these government assistance programs, as any disabled person with more than $2000 of assets cannot still qualify.
Setting It Up
Working with a financial advisor can help you plan out your life insurance policy. This individual will help you decide the amount of life insurance you want to invest in. However, when it comes to setting up a trust, you’re going to need the assistance of an attorney. Discuss the issues with both of these people before putting them on paper. Once it’s committed to paper, it can be a bit of a hassle to change anything. While it’s much easier to only have to do this once, if you really need to alter anything, don’t hesitate to do so.
Life insurance isn’t a simple process. Shopping around for the best quotes for your personal situation is the fastest, most efficient way to make sure you aren’t spending too much on your policy. Don’t wait; the sooner you put your life insurance policy into place, the better off you’ll be. If you have children or dependents that rely on you, life insurance is an absolute necessity. If something happens to you and you don’t have a life insurance plan, your family may have more problems than the grief alone.