Should you name a trust as a life insurance beneficiary?

A designated beneficiary is one of the most important parts of a life insurance policy. Many people question how they should organize their life insurance beneficiaries in the most efficient way. You want to make sure your spouse, partner, kids or other heirs are well taken care of. You also want to help them make the most of their benefit.

One way that people look to minimize the amount of taxes that will be taken out of their life insurance payout is by making the primary beneficiary of their life insurance policy a trust. However, this process isn’t always as simple as it seems — and there are some legal and tax implications to consider before making this financial move.

Here’s what you need to consider before naming a trust as a life insurance beneficiary:

Common trusts used as beneficiaries

First, let’s go over the two different kinds of trusts you can list as your life insurance’s primary or contingent beneficiary. An irrevocable trust or a revocable trust can both be listed as your life insurance beneficiary, and they each come with their own set of pros and cons. Generally, most young families (including my own) tend to choose a revocable trust when the time comes. Let’s talk about why.

A revocable trust protects assets as the trust-owner (you) ages. You can take distributions from the trust until you pass away, at which time they’re transferred to the trust’s beneficiaries. A revocable trust can also be modified by the owner, whereas an irrevocable trust can’t.

This is an ideal situation for families who want a trust to protect their life insurance benefits and reserve them for the cost of caring for their kids, or as a future inheritance for their (currently) minor children. The flexibility that a revocable living trust has means that you can change the trust as your wishes or financial needs change — which is perfect for a growing family.

Tax and financial advantages of trusts

A lot of people are under the impression that their life insurance policy’s benefit will pass seamlessly to their heirs. Unfortunately, that’s not always true.

Life insurance policy payouts typically go to a spouse or partner — and this type of distribution is usually tax-free. However, that’s not always the case if you should name someone else as a beneficiary of your policy. For example, if something were to happen to both you and your spouse, you may want your money to go to a sibling because they’re going to care for your kids. But if your entire estate is going to them, you may run into three issues:

1. Your estate may be large enough that you’ll owe estate tax on a portion of it.
2. You have no real control over how your life insurance benefit is used once it’s willed to them.
3. Your benefit may enter a probate process – which can be expensive, and delay the delivery of a benefit to your beneficiary.

Even if your sibling is the most trustworthy person in the world, it’s worthwhile to put some stipulations in place to make sure your kids are cared for in the way you want them to be. A revocable living trust helps to ensure that the funds you want to be used to care for your kids will go toward them directly over time. You have full control over how much your trust pays out and when.

How to create a trust

There are a couple options for creating a trust. First, an estate planning attorney can establish one for you. Estate Planning Attorney Rebecca Neale says she generally charges $2,900 to create a trust.

There also might be costs associated with changing the title on deeds for property that you want to transfer to the trust.

Trust & Will, which is a technology company that offers an online solution for creating a trust or legal, offers an individual trust for $399 or $499 for couples. Through Haven Life Plus, a rider to the Haven Term life insurance policy, eligible policyholders can enjoy no-cost trust services from Trust & Will if they don’t make an online will. Learn more about Haven Life Plus.

Pros of listing a trust as your life insurance beneficiary

When it comes to beneficiary designation, listing a trust as a beneficiary might be preferred by some. When you list a trust as your life insurance beneficiary, you’re able to maneuver around probate, estate tax (depending on your unique financial situation — make sure you’re consulting a CPA), and you’re able to control how your wealth is used, or when it’s given to your kids.

A trust helps you to sidestep probate

Probate is a process in which your estate is proven, and then distributed to your heirs. Probate can take a long time — and it can be expensive, too. This means that the money you want used to take care of your kids could be delayed in getting to their caregiver. Alternatively, it could have a notable chunk taken out of it due to legal fees, or to pay your outstanding debts or taxes. When you’re trying to make sure your kids are taken care of in the event of a tragedy — probate is the last thing you want to have family members deal with.

A trust helps you to control the cash flow that’s distributed to your kids

If you want a certain amount of money to go to your kids’ care when they’re minors, you can adjust the trust to pay out to cover these costs. Then, if you want them to receive the funds that remain when they turn 18, you can create a stipulation that gives them the remainder of your life insurance benefit at that time. The flexibility here is key for young and growing families because you can adjust the revocable trust in an ongoing capacity as your kids get older, and your financial needs and wishes change.

Cons of listing a trust as your life insurance beneficiary

Even though revocable living trusts have a lot of upsides for young parents, they also come with a few key drawbacks that might make them a non-ideal fit for you:

A trust can be pricey to set up

The biggest deterrent that I see people run into when setting up a revocable living trust is the cost and time-spend required. Costs might include expenses related to setting up deeds, and documents transferring ownership, as well as legal fees. However, the costs you’re incurring now mean that you’re saving your heirs the same set-up and transfer costs (as well as the potential costs associated with probate). Funding the trust also can be challenging.

Although the costs associated with setting up a revocable living trust are relatively easy to stomach, especially when you know it’s going to benefit your kids someday, some people still struggle to find the time to go through the process. As an entrepreneur, and a busy mom of two, I completely understand feeling like there aren’t enough hours in the day.

A trust demands that you have additional estate planning pieces in place

You need a will to set up a trust. Just remember that heirs can contest a trust for longer than a traditional will (statutes usually range from 1 to 5 years depending on where you live).

All that being said — setting up your estate plan is an important to-do list item. Most people overestimate the amount of time they’ll need to spend getting everything in place. Partnering with an estate planning attorney and a CPA can help to take some of the admin work off of your plate, and ensure that everything gets done correctly. The financial and time investment required may be worth the peace of mind you’ll get knowing that your kids will always be taken care of, even if they lose both you and your partner.

Should a trust be a primary or a contingent beneficiary?

Personally, I have named my husband as the primary beneficiary of my life insurance policy. Our revocable trust is named as the contingent beneficiary. This way, should something happen to both of us, my life insurance policy goes to a trust for our two kids.

Typically, I recommend other families set up their estate plan in a similar way, but it’s also worth mentioning that I’m not a CPA or an estate planning attorney. This is a consideration that you should bring up to your financial team to make sure naming a revocable trust as a primary beneficiary or a contingent beneficiary on your life insurance policy meets your family’s unique needs.

Is a trust beneficiary right for you?

Typically, having a spouse listed as a beneficiary on your life insurance policy is the most common choice. When a benefit goes to your spouse in a lump sum after you pass away, it’s usually exempt from estate and income taxes.

However, if you want your life insurance policy to go directly to the care (and future inheritance) of your minor children, having a trust listed as your life insurance beneficiary might make the most sense. Talking to a trusted estate planning attorney and a financial planner can help you to build a beneficiary strategy that makes sense for you now, while also passing on as much of your estate as possible to your heirs.