most states protect life insurance policies from creditors, most buyer questions come from the confusion created with ownership and beneficiary designations because of tax treatment. This is a rather complicated issue when it comes to life insurance proceeds, because there are two tax issues that raise their head: U.S. ordinary income taxes (for the beneficiary) and federal estate taxes (on the estate tax return of the deceased).
Ownership of the Policy
If your life insurance beneficiary is your spouse, generally there's no issue; assets pass estate-tax free between husbands and wives no matter what the amount (as long as the spouse is a U.S. citizen). However, if your estate is large (more than $2 million), you may want to consider putting ownership of your life insurance policy in an irrevocable life insurance trust in anticipation of the taxes due at the death of the surviving spouse.
Why? By having the irrevocable trust own the policy, the proceeds of the death benefit payout will not be included as part of your taxable estate, which can be taxed as high as 45%. Revocable trusts will not qualify for the exclusion. If the policy is a new policy, name the trust as owner immediately. If the policy is existing, you can transfer ownership to the trust. Beware: to eliminate deathbed transfers, the government mandates that you must survive the transfer by three years or your estate will be taxed anyway. Also, if the cash value of the policy that you would get if you cashed in now instead of when you die is more than $14,000 (as of 2013), the transfer may use up part of your gift and estate tax exemptions.
Life Insurance Beneficiaries
In most cases, it makes better sense to name your beneficiaries individually on life insurance policies versus naming a trust as beneficiary. If your beneficiaries have creditor issues, mental health problems, can't be trusted with large sums of cash or their primary beneficiaries are minors or have drug issues, or there other special scenarios, then naming the trust as beneficiary might be a better route.
For federal tax purposes, if a spouse is named as beneficiary then life insurance proceeds received upon the death of the insured are generally income and estate tax free (if paid in lump sum). Trusts are not considered individuals; therefore, life insurance proceeds paid to trusts are generally subjected to estate tax. Also, the proceeds payable to a trust may not qualify for the inheritance tax exemption provided by some states for insurance payable to a named beneficiary. In such states, a higher tax may be owed.
Let's take a step back here. There seems to be a number of things going on.
You refer to a trust. Was the trust set up to hold on to your life insurance policies? If so, then why wouldn't you make the trust the owner and beneficiary of the policies? The trustee would then disburse the proceeds according to your wishes. Why else would you set up the trust?
Let's now focus on the beneficiaries you mention. Are these people whom you want to receive the life insurance benefit? If you want them to be paid the proceeds directly, then you shouldn't have the benefit paid to the trust.
See the confusion?
Looks like there's more here than meets the eye. I think you need to think through some basic estate planning principles:
Who do you want to get your money?
How much do you want them to get?
What assets do you want to give them?
And when do you want them to get it?
These answers will help you determine how much control you want to exercise “from the grave,” so to speak, with a trust and other tools that can execute your wishes when you are gone. Once you make these decisions, it'll be easier to set the owner and beneficiary designations on your life insurance policies.
If you need further clarification, please do not hesitate to reach out to me.