Life Insurance Trusts: Essentials for Estate Planning

Explore the essentials of life insurance trusts with White Oak Wills & Trusts, LLC. Learn how these trusts can protect your assets and benefit your heirs.

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What Are Life Insurance Trusts?

A life insurance policy is a contract between an individual and an insurance company. In exchange for periodic premium payments, the insurance company pays a lump sum (death benefits) to the policyholder’s family or beneficiaries upon the policyholder’s death.

A life insurance policy can serve as a safety net for families against the death of a breadwinner. However, the life insurance proceeds are at risk of loss due to possible creditor claims and tax liabilities that could arise after the policyholder dies. If you own a life insurance policy, such claims could defeat the purpose of your investment, leaving your loved ones with little of the funds you intended them to have.

But there is a way out. You could create a life insurance trust to secure the insurance benefits for your loved ones. A life insurance trust is a common estate planning tool that would allow you to shield the proceeds of your life insurance trust from adverse claims and future estate taxes, depending on its structure. 

Life insurance trusts are legal instruments. So, if you’d like to create one, understanding the applicable laws for such instruments is crucial to ensure that your trust is valid and effective.

At White Oak Wills & Trusts, LLC, our dedicated team offers comprehensive estate planning services. We are passionate about protecting what matters most to you and can help you set up a detailed life insurance trust that aligns with your personal estate planning goals.

Below, we explain the basics of life insurance trusts and specific ways we can help with the creation process. Please read on to learn more.

Why You May Need a Life Insurance Trust

A life insurance policy can be classified as an asset, especially if it has cash value. So even though the end goal is to provide funds for the policyholder’s heirs after their death, the policyholder can take a loan against the policy or surrender it in exchange for cash at any time.

However, such policies may be subject to adverse claims from the policyholder’s creditors (including judgment creditors who triumphed over the policyholder in a lawsuit) and estate taxes depending on the state law and the value of the policyholder’s overall estate.

Thankfully, by ORS 743.046, you can protect your life insurance policy from creditors if there’s a designated beneficiary of the policy. Unfortunately, appointing a designated beneficiary cannot help you avoid state and federal estate taxes.

The federal estate tax, which applies across the U.S., must be paid after a person dies and before their estate is distributed if the taxable estate is valued above a certain threshold ($13.61 million for individuals who died in 2024). Because the federal estate tax figures are so high, only a few extremely wealthy estates have to pay it. 

The real problem lies with Oregon’s estate tax. The estate tax exemption threshold in Oregon is  $1 million. This figure is significantly lower than the federal amount, and many estates will be caught by it. Also, the estate tax rate in Oregon can go as high as 16 percent, depending on the estate’s value. Deducting such amounts from the estate or, in this context, the life insurance benefits would significantly affect what comes to the estate’s beneficiaries, hence the need for proper estate planning to prevent such an outcome.

That’s where life insurance trusts come in. 

How Life Insurance Trusts Work

Life insurance trusts are specialized legal entities designed to hold ownership of a life insurance policy. The primary goal of this type of trust is to ensure that the life insurance death benefit is not considered part of the deceased’s taxable estate, potentially eliminating estate taxes over the policy and possibly the entire estate. 

This legal arrangement is created when the owner of an insurance policy transfers it to a legal entity (the trust) to be managed by a third party (the trustee) for the benefit of specific beneficiaries. By this act, the trust becomes the policy owner. As a result, when the grantor, that is, the trust creator, passes away, the death benefit paid out is not counted for estate tax purposes.

Benefits of Life Insurance Trusts

Aside from helping to avoid estate taxes, life insurance trusts also have other estate planning benefits. 

Trusts generally are used as a tool to avoid probate. Probate is a legal process during which the court supervises the distribution of a deceased’s assets. The process could be long and complex depending on the circumstances and could lead to financial expenses for the deceased’s heirs. As such, probate avoidance is a popular estate planning goal since most people wish to spare their heirs the hassles of the process.

When it comes to life insurance policies, probate can also be avoided if there is a designated beneficiary. However, it may not be wise to allow certain beneficiaries to access the complete life insurance proceeds since they may be incapable of properly managing their finances.

A life insurance trust will allow you to leave specific instructions on a sustainable payment structure if your beneficiary falls within this class. That way, you can ensure their financial well-being for a long time after you’re gone.

Types of Life Insurance Trusts 

Generally, trusts made during a person’s lifetime (living trusts) may be revocable or irrevocable. So, in theory, there can be two types of life insurance trusts – revocable or irrevocable life insurance trusts.

However, there are limitations to revocable trusts that would make them ineffective in protecting life insurance policies from estate taxes. 

With a revocable trust, the grantor maintains much control over the trust and its administration. They also have the power to revoke or terminate the trust at any time without the trustee’s or beneficiaries’ consent. Because there is still a link to the owner, the assets within a revocable trust are considered part of the grantor’s taxable estate, which may result in estate taxes upon death.

For maximum protection, the transfer of the life insurance policy must be absolute, which is why irrevocable life insurance trusts (ILITs) are more common.

Once established, an irrevocable life insurance trust cannot be easily modified, and the transfer of ownership to the trust is considered complete. As such, the life insurance policy would not be counted as part of the policyholder’s estate, making it more appropriate for estate tax purposes.

Setting Up Your Life Insurance Trust

To set up an effective life insurance trust, you’ll need to create an irrevocable trust document that complies with the legal requirements in the Oregon Uniform Trust Code and specifies the trustee and the beneficiaries.

Once the trust is created, you must notify your insurance company and make the trustee a designated beneficiary. The trustee will distribute the assets according to your instructions in the trust document after you pass. 

You may need to complete some forms with the insurance company and give them a copy of the trust document, depending on their specific policy.

The insurance company is also required to notify the Director of the Department of Consumer and Business Services and get their approval before documenting your trust.

These steps could be difficult to navigate, and any mistakes, especially when drafting the trust document, could render your efforts ineffective. That’s why the legal guidance of an estate planning attorney is important to ensure that your trust meets all the legal requirements and can be enforced even in your absence.

How White Oak Wills & Trusts, LLC Can Help

At White Oak Wills & Trusts, LLC, we provide personalized estate planning solutions tailored to each client’s needs.

We recognize the complexity of most estate planning tools and strategies, including life insurance trusts, and stand ready to offer experienced guidance that ensures that your assets are managed according to your exact directives.

We can

  • Advice you on whether a life insurance trust is appropriate for your estate planning goals
  • Help you create a valid and effective trust document that clearly expresses your instructions and meets the required legal standards.
  • Offer comprehensive estate planning services and keep your will and trust updated to protect the rest of your estate from possible estate taxes, third-party liability, or probate, depending on your unique needs.

Our experience and commitment to providing effective estate planning solutions for our clients sets us apart. We’d be glad to apply our skills and extensive estate law knowledge to your case and help you achieve peace of mind for the future.

Contact Us Today 

Life insurance trusts are an indispensable tool for thoughtful estate planning. The complexity these trusts carry requires top-notch legal skills that we are prepared to provide.

For personalized advice and to create an effective trust that safeguards your interests, we invite you to contact us at White Oak Wills & Trusts, LLC. Let us take the next steps toward securing your assets and the future of your loved ones together.

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