What is a Life insurance trust?

A Life insurance trust holds a life insurance policy. 

At the death of the creator, it will pay out a death benefit. In order to receive the death benefit, the owner of the policy must pay a premium. A life insurance policy that is already previously held by the grantor can be transferred to the trust to create a life insurance trust. Once the policy has been created and is held by the trust, it is no longer included in the individuals gross estate. Life insurance trusts are a great vehicle to protect from debtors and creditors.

So, what happens if you decide to terminate life insurance trust, or need to make changes to the life insurance trust? One easy way to terminate a life insurance trust, the grantor to stops making the premium payments, known as gifts, to the trust. If the grantor stops making payments to the trust, then the policy will lapse. This causes the purpose of the trust to be eliminated. If you are looking to making changes to the life insurance trust rather than terminating, there are a few options. 

How to make the change?

The three most common ways to change a life insurance trust are:

  • Decanting

  • Non-judicial Settlement Agreement

  • Transferring an ILIT


When an Irrevocable life insurance trust is created, it is sealed and the material of the trust document cannot be changed. Oftentimes, trusts that were created a long time ago do not have the proper language implemented to reflect the situations of today. Decanting a trust is typically done when there is an irrevocable trust that is difficult to amend or revoke. Decanting a life insurance trust is similar to upgrading to a new phone, but not erasing the content of the old phone. In the terms of the trust, you are upgrading unhelpful provisions of a trust, but not changing the interest of the beneficiaries of the original trust. Decanting can be useful for a number of reasons. For example, creditor protection. If a beneficiary is set to receive the proceeds of a trust at a certain age, the distributions could be subject to creditors. However, if the trust is decanted, the new trust terms could extend, and the assets would be preserved from the creditors. South Dakota has ranked #1 for the last 6 years for their decanting statutes.

Non-Judicial Settlement Agreement

Generally, if you are wanting to change the contents of the life insurance trust you might have to jump through a few hoops to get there. This can make the process expensive, and long, especially if you have to go to court. Depending on the state, you might have an option to use a non-judicial settlement agreement.  A non-judicial settlement agreement is a way to modify or address issues in trust that might need to be change or are silent. One important factor to note is not every state statutes is created the same. States like South Dakota, allow interested parties to use a non- judicial settlement agreement to make changes to the trust. For example, if a beneficiary of a life insurance trust lives in a high tax state, then they can have their assets depleted by Uncle Sam. They governing law might state that the life insurance trust must be administered in the state that it resides, and this can make the beneficiary feel stuck. The good news, if that state has statue granting them to use a non-judicial settlement agreement, then they can potentially change the governing law to a more tax friendly state like South Dakota.

Transferring an ILIT

There are certain circumstances where a old trust can be merged into a new life insurance trust, but it is limited and requires a special legal document. An option more common is for a new life insurance trust to be created which fixes any problems and have it purchase the policy. The policy can be sold at its fair market value. Since the policy is never owned by the insured, there is no issue with the inclusion rule, and the death proceeds avoid paying the estate tax. It is important to understand that the transfer of the life insurance trust must meet certain exceptions to keep the proceeds free from paying income tax. Transferring the life insurance trust might be a better option than terminating the trust and paying a termination fee. 

Termination Fees

Today's life insurance market place is complex and ever changing. This is a big reason why less and less corporate trustees are interested in managing life insurances trusts. Sadly, the few that are willing, often administer life insurance trusts poorly. This serves as a disadvantage when a beneficiary wants to make a choice. Usually, if a beneficiary wants to take an immediate distribution of the death benefit of the life insurance trust, they will have to pay a termination fee. These fees can range from 1% up 3% of the death benefit of the life insurance trust. Some trustees use this as a way to keep you invested. It is important to understand what the termination fees might be for your corporate trustee to make the best decision.