Understanding Estate Taxes
18. How insurance trust works
You transfer an existing insurance policy to the trust, making the trust the owner and beneficiary of the policy. After you die, the insurance proceeds will be paid to the trust. The trustee you have named will then use the funds to provide for the beneficiaries of the trust (usually your spouse, children or other loved ones) according to the instructions you put in the trust when you set it up.
There is one catch-if you die within three years of transferring an existing policy to the trust, the insurance will be included in your estate. But that's what would happen anyway, without the trust. However, if the trust buys a new policy, the three-year limitation does not apply. Also, this is an irrevocable trust, so you can't change it after you set it up.*
Buying life insurance-through an insurance trust-can be a great way to pay estate taxes at a dramatically reduced cost. Let's look at an example.
*You can appoint someone else to make changes to the trust. But the tax implications are not clear, and you have no guarantee the person will make the changes you want.