How Life Insurance and Annuities Work With a Trust

Many people assume that because an insurance policy has a named beneficiary, there’s nothing else to do. In fact, poorly handled life insurance can end up unpaid, paid to the wrong person, or adding estate tax.

Do Life Insurance Proceeds Go Through Probate?

Usually not. The insurer pays whoever is named as beneficiary on the policy. The exceptions:
- The beneficiary is “my estate”;
- Every named beneficiary died before you and no contingent beneficiary was named.
In those cases, the proceeds become part of the estate and go through probate.

What’s Wrong With Naming a Minor Child as Beneficiary?

Insurers will not pay a minor directly. Your family may have to:
- Ask Surrogate’s Court to appoint a property guardian, with court supervision; or
- Pay the money to a custodian under the Uniform Transfers to Minors Act, in which case the child usually receives everything at age 21.
Naming a trust as beneficiary lets the money reach your children in stages and for purposes you choose.

Should Life Insurance Be “Put Into” My Revocable Trust?

Usually you don’t need to change the policy owner. Simply name your revocable trust as beneficiary. The proceeds go into the trust and are distributed under its terms.

Does Life Insurance Increase Estate Tax?

Yes. If you own the policy, the death benefit is generally included in your taxable estate (IRC §2042). In New York, this matters a great deal:

Example (hypothetical): Mr. Wang’s home, savings and retirement accounts total about $6,000,000, and he has a $2,000,000 life insurance policy. He thinks he “only has $6 million,” below New York’s 2026 exclusion of $7,350,000. But with the insurance proceeds, his taxable estate is about $8,000,000, over the 105% “cliff” of $7,717,500, so New York estate tax applies from the first dollar.

How Can Insurance Proceeds Be Kept Out of the Estate?

A common solution is an irrevocable life insurance trust (ILIT):

The trust buys and owns the policy and is also its beneficiary;
You cannot serve as trustee; usually a family member or professional serves;
Each year you gift the premium amount to the trust, which pays the premium. The trustee usually sends the beneficiaries a withdrawal-right notice (a “Crummey notice”) so the gift qualifies for the annual exclusion;
When properly structured, the death benefit is not included in your estate and is distributed under the trust’s terms.

Can an Existing Policy Be Transferred to an ILIT?

Yes, but there is a three-year rule: if you transfer an existing policy to an ILIT and die within three years, the proceeds are still included in your estate (IRC §2035). So, if your health allows, the ILIT often buys a new policy directly.

Couldn’t My Adult Child Just Own the Policy?

That keeps the insurance out of your estate, but the policy becomes your child’s property, exposed to your child’s debts or divorce, and your child could change the beneficiary or cash it in. An ILIT usually offers better control and protection.

What About Group Life Insurance at Work?

Group life insurance also pays according to the beneficiary form. Check it whenever you start a job, change jobs, marry or divorce. If it is part of an employee benefit plan governed by federal law (ERISA), it generally pays whoever is named on the plan’s form, so update it yourself after a divorce.

What Should I Know About Annuities?

Annuities also pay by beneficiary designation, and a spouse beneficiary can usually continue the contract;
Inherited annuities do not get a step-up in basis; the gain is taxed as ordinary income;
Changing an annuity’s owner to a trust can cause tax problems. The usual approach is to keep yourself as owner and name the trust as beneficiary. Consult an advisor before making any change.

Do I Really Need a Contingent Beneficiary?

Yes. If your primary beneficiary dies before you, a contingent beneficiary keeps the proceeds out of probate.

The Bottom Line

Life insurance comes down to three things: name the right beneficiary, don’t name minors directly, and consider an ILIT for large policies. The size of your insurance often determines whether your family hits New York’s estate tax cliff.

Attorney’s perspective

In every estate plan, I add the death benefit of every life insurance policy to the total. For many families, that is exactly what brings them near New York’s estate tax cliff. When policies are large, I work with your insurance advisor to decide whether a life insurance trust makes sense.

For advice about your own family’s situation, call +1 718-218-5805 or schedule a consultation. We meet clients in Flushing and Manhattan, in English or Chinese.

Series overview

This article is for general information only and is not legal advice. Reading it does not create an attorney-client relationship. For advice about your situation, please contact us.

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