Can You Fund a Trust with Life Insurance?

When it comes to estate planning in Texas, families often wonder how life insurance fits into the big picture. One of the most powerful strategies is using life insurance to fund a trust. This approach can protect your loved ones, minimize estate taxes, and ensure your wishes are honored—especially if you have minor children or significant assets to manage after you're gone. This article examines how this strategy works, and when it might make sense for you and your family.

What Does It Mean to Fund a Trust with Life Insurance?

A trust is a legal structure where a third party, called a trustee, manages assets on behalf of your chosen beneficiaries. When you fund a trust with life insurance, you’re using the proceeds from a life insurance policy to supply the trust with money after your passing. This allows the trustee to use those funds according to the instructions you’ve laid out in your estate plan.

In practice, this usually means naming the trust as the beneficiary of your life insurance policy, or even having the trust own the policy outright. Read more in our article, Does a Trust Have to Be Funded to Be Valid?

Why Use Life Insurance in a Trust?

There are several advantages to this approach:

1. Provides Immediate Liquidity

Life insurance can be paid out quickly—often within weeks—providing cash when your family may need it most. This can be especially helpful for covering funeral expenses, debts, or legal fees without waiting for probate or selling other assets.

2. Supports Minor Children

If you have young children, using life insurance to fund a trust gives you more control over how the money is used. Instead of leaving a large sum directly to a minor, you can direct a trustee to use the funds for education, healthcare, or living expenses until the child reaches an age where they can manage the money responsibly.

3. Avoids Probate

Assets inside a properly structured trust typically do not go through probate, saving your family time and legal fees. This is especially important in Texas, where the probate process, though streamlined compared to some states, can still be stressful and time-consuming.

4. Minimizes Estate Taxes

A major reason some people choose to place life insurance in a trust—especially a type known as an Irrevocable Life Insurance Trust (ILIT)—is to avoid having the insurance payout included in their taxable estate. This can be especially useful for larger estates or for those who expect to grow their wealth over time.

Revocable vs. Irrevocable Trusts: What’s the Difference?

There are two main types of trusts used in estate planning:

Revocable Living Trust

This type of trust can be changed or revoked during your lifetime. It’s a popular choice for avoiding probate and managing assets while you're alive. However, life insurance owned by a revocable trust is still considered part of your estate for tax purposes.

Irrevocable Life Insurance Trust (ILIT)

An ILIT is a special kind of trust that, once created, cannot be changed. If properly structured, it keeps the life insurance proceeds out of your estate, helping to minimize estate taxes. However, to work correctly, the trust must own the policy from the beginning or you must survive at least three years after transferring an existing policy into the trust.

Learn more about choosing the right type of trust in our article, Do You Need a Revocable or an Irrevocable Trust?

How to Fund a Trust with Life Insurance

There are two ways to use life insurance in a trust:

1. Transfer an Existing Policy

If you already own a life insurance policy, you can transfer ownership to your trust. However, remember the three-year rule—if you pass away within three years of the transfer, the policy proceeds may still be included in your estate.

2. Have the Trust Buy the Policy

The cleaner approach is to have the trust purchase the life insurance policy from the start. This avoids the three-year rule and ensures the trust is the legal owner and beneficiary of the policy.

Either way, working with an experienced estate planning attorney in San Antonio is crucial to make sure everything is set up correctly.

Additional Considerations for Funding a Trust with Life Insurance

Using life insurance to fund a trust adds some complexity to your estate plan, but the benefits often outweigh the extra effort. Here are a few additional points to keep in mind:

• Annual Premium Payments: The trust will need money to pay policy premiums. Typically, you’ll gift funds to the trust each year, and your trustee will use those funds to pay the insurance company.
• Gift Tax Rules: Contributions to the trust may count toward your annual gift tax exclusion or lifetime exemption. It’s important to coordinate with a tax advisor to avoid surprises.
• Beneficiary Notifications: Your trustee may need to notify beneficiaries each year when a contribution is made, even if they won’t access the funds immediately.

Speak with an Estate Planning Law Firm for Best Strategies

If you’re concerned about providing for young children, avoiding probate delays, or protecting your estate from taxes, funding a trust with life insurance might be a smart move. Every family’s situation is different, and the best way to find out what works for you is to speak with a qualified estate planning attorney.

At McCammon Law, P.C., we help families in the San Antonio area design estate plans that bring peace of mind and long-term protection.  Request a consultation with McCammon Law whether you’re just getting started with estate planning or updating an existing plan to make informed choices that benefit you and your loved ones.

References: Forbes (Sep. 17, 2020) “How To Fund A Trust With Life Insurance” and J.P. Morgan (Nov. 27, 2024) “When does it make sense for a trust to own your life insurance policy?”