5 Surprising Reasons Why You Shouldn’t Put Your Life Insurance in a Trust

Are you considering putting your life insurance policy in a trust? While many financial advisors recommend this strategy for estate planning, it’s not always the best option for everyone Before you make this decision, let’s explore some important drawbacks that might make you think twice.

As someone who’s spent years helping clients navigate these complex financial waters, I’ve seen firsthand how life insurance trusts can sometimes create more problems than they solve. Let’s dive into why you might want to keep your life insurance policy outside of a trust arrangement.

What Exactly Is a Life Insurance Trust?

Before we jump into the disadvantages, let’s clarify what we’re talking about. A life insurance trust is a legal arrangement where you transfer ownership of your life insurance policy to a trust. The trust becomes the policy owner and a trustee manages it according to your instructions.

There are two main types:

• Revocable trusts – Can be changed or terminated by you during your lifetime
• Irrevocable trusts – Once established, cannot be modified or canceled

While these trusts can provide benefits like estate tax advantages and asset protection, they come with significant drawbacks that aren’t always fully explained.

1. You’ll Lose Control Over Your Policy

One of the biggest reasons to think twice about putting your life insurance in a trust is the loss of control over your policy.

Once you transfer your life insurance policy to a trust, you’re no longer the legal owner. This means:

• You can’t easily change beneficiaries
• You can’t adjust coverage amounts
• You can’t cancel the policy if your needs change
• You may lose access to the policy’s cash value

This loss of control is particularly severe with irrevocable trusts. As the Accounting Insights team notes, “If a policyholder later decides they no longer need the coverage or want to change the trust’s terms, they may have no legal means to do so.”

This rigidity becomes problematic if your financial situation changes – maybe you experience unexpected medical expenses or your estate planning goals shift. In these cases, you’d likely regret not having direct access to your policy.

2. The Administrative Burden Can Be Overwhelming

Trust administration isn’t for the faint of heart. When you place life insurance in a trust, you’re signing up for ongoing administrative responsibilities that can be time-consuming and expensive.

These responsibilities include:

• Ensuring premium payments are made on time
• Maintaining compliance with legal requirements
• Keeping detailed financial records
• Issuing formal notices to beneficiaries (especially with Crummey provisions)
• Filing annual trust tax returns

The trustee must handle all these tasks, and if they fail to do so properly, the policy could lapse or trigger unexpected tax consequences. Even if you hire a professional trustee, you’ll be paying ongoing fees that can add up over time.

3. Higher Tax Burdens May Apply

While trusts are often created for tax benefits, they can actually create tax disadvantages in certain situations.

Trust tax rates escalate much faster than individual rates. In 2024, trusts reach the highest federal tax bracket of 37% at just $15,200 of taxable income. Compare that to individual taxpayers who don’t hit that rate until much higher income levels.

If your trust retains any earnings instead of distributing them immediately:

• Investment gains may be taxed at compressed trust tax rates
• The trust may need to file a separate tax return
• Generation-skipping transfer taxes might apply if beneficiaries include grandchildren

As Kiplinger points out, certain assets like retirement accounts should not be transferred into trusts because doing so would “require a withdrawal and likely trigger income tax.”

4. Complex Funding Requirements

Keeping a life insurance trust properly funded is another headache you might not anticipate.

Once the policy is in the trust, you can’t directly pay the premiums anymore. Instead:

• The trust must have sufficient assets to cover premium payments
• Annual gifts to the trust must navigate gift tax rules ($18,000 per recipient in 2024)
• Many trusts require Crummey powers (temporary withdrawal rights for beneficiaries)
• Each gift to the trust may require formal notification to beneficiaries

If the trust runs out of money to pay premiums, the policy could lapse, rendering the entire arrangement useless. The Guardian article notes, “Using a permanent universal policy can also be problematic because the death benefit amount typically isn’t guaranteed. Under certain circumstances, it can fluctuate, leaving the trust underfunded.”

5. Potential Liquidity Issues for Your Estate

Life insurance proceeds are often used to provide immediate liquidity for an estate to cover expenses like:

• Funeral costs
• Outstanding debts
• Estate taxes
• Probate fees

When your policy is held in a trust, these funds may not be readily available to your estate. This could force your heirs to sell other assets, possibly at unfavorable times, to cover immediate expenses.

As Accounting Insights explains, “When a policy is held within a trust, the funds may not be immediately accessible to the estate, potentially forcing heirs to sell other assets, such as real estate or investments, at inopportune times.”

Who Should Consider Keeping Life Insurance Outside a Trust?

Based on the information from our sources, here are some situations where placing life insurance in a trust might NOT be advisable:

Alternatives to Consider

Instead of placing your life insurance in a trust, consider these alternatives:

• Properly structured beneficiary designations – Simply naming specific beneficiaries can avoid probate while maintaining your control over the policy.
• Payable-on-death (POD) arrangements – As Kiplinger suggests, “When you opened your checking or savings account, your financial institution or bank may not have asked you to select a beneficiary when you signed the signature card. Review these accounts for a payable-on-death (POD) option that allows you to add primary and secondary beneficiaries.”
• Simpler estate planning tools – For many people, a will combined with properly designated beneficiaries is sufficient.
• Regular review of your estate plan – As your life circumstances change, periodically revisit your estate planning strategy.

When a Life Insurance Trust DOES Make Sense

Despite the disadvantages, there are legitimate reasons to consider a life insurance trust:

• Your estate exceeds the federal estate tax exemption ($13.61 million in 2024)
• You want to provide for a child with special needs without jeopardizing government benefits
• You need to protect assets from creditors
• You want to control how and when beneficiaries receive funds
• You wish to create a multi-generational legacy

The Guardian article notes, “If you have substantial wealth you want to protect, a life insurance trust could be a valuable tool for estate planning. It can also be useful if you want to leave money to underage or special-needs children.”

Final Thoughts: Proceed with Caution

Life insurance trusts are complex legal arrangements that aren’t right for everyone. Before making this decision, we recommend:

1. Consulting with both a financial advisor and an estate planning attorney
2. Carefully considering your long-term financial goals
3. Evaluating whether the benefits outweigh the costs and administrative burdens
4. Exploring simpler alternatives that might achieve the same objectives

As the Accounting Insights team wisely advises, policyholders should “carefully evaluate” the restrictions and responsibilities that come with placing life insurance in a trust.

Remember, what works for someone else might not be the best choice for your unique situation. The most important thing is to make an informed decision based on your specific circumstances and goals.

A life insurance policy does not need to be in a trust, as a trust is only necessary for individuals with substantial wealth who want to avoid estate taxes, provide for underage or special-needs beneficiaries, or gain more control over how the payout is distributed.

No, a life insurance beneficiary designation generally overrides a trust, as the individual named on the beneficiary form receives the payout directly, bypassing the trust and the probate process. However, you can designate a trust as the beneficiary of a life insurance policy, which can be a strategic move for complex estate planning or to provide long-term financial management for your beneficiaries.

The primary downsides of putting assets in a trust are upfront costs, increased complexity, potential difficulties when refinancing or selling assets, the need for proper and timely funding of the trust, and the potential loss of direct control over those assets.