Naming a Trust as Beneficiary of Life Insurance: How It Works and Where It Fails

Can a trust be the beneficiary of a life insurance policy?

Yes. A policy pays the beneficiary its designation names, and that can be the trustee of a trust; the contract and state law govern the payment, not the will. The choice affects estate tax. Proceeds receivable by the insured’s executor are in the gross estate, and so are proceeds payable to anyone else if the insured held incidents of ownership at death (IRC § 2042). Death proceeds are generally excluded from income (IRC § 101(a)(1)).

This page covers a trust named on a life insurance beneficiary form: what the form does, the federal estate- and income-tax results, and the points at which a designation fails. Naming a trust on an annuity raises different income-tax rules, covered on the annuity-beneficiary page.

What the beneficiary form does

A beneficiary designation is a term of the insurance contract. At the insured’s death the insurer pays the beneficiary the contract names. The U.S. Supreme Court has grouped life insurance policies with revocable trusts and pension accounts as “will substitutes” (Sveen v. Melin, 584 U.S. 811 (2018)). The estate-tax regulation draws the same line, separating proceeds receivable by the executor or payable to the estate from proceeds receivable by other beneficiaries (Treas. Reg. § 20.2042-1).

Who may be named, what the form must say, and how a change is made are set by the policy and by state law. No single federal rule covers those points for individually owned policies.

When the form names a trustee, the insurer pays the trustee. The trustee then holds or distributes the money under the trust instrument. The form decides that the trust receives the proceeds; the trust decides who benefits from them and when. A trust that is not named on the form receives nothing from the policy, which is the general point made on the trust-funding page. The cross-asset version of this rule is on beneficiary designations and wills.

Estate tax by beneficiary

Section 2042 has two parts. Paragraph (1) covers insurance receivable by the executor. Paragraph (2) covers insurance receivable by all other beneficiaries when the decedent held any incident of ownership at death. The regulation fills in the detail.

Inclusion is not the same as tax. Property that passes to a surviving spouse is deductible to the extent it is included in the gross estate, within the limits of § 2056(b) and (d) (IRC § 2056(a)), and the basic exclusion amount is $15,000,000 for a decedent dying in 2026 (IRC § 2010(c)(3)). The exemption is explained on the lifetime-exemption page.

Where insurance proceeds received by a beneficiary other than the executor are part of a gross estate on which tax has been paid, the executor is entitled to recover from that beneficiary a proportionate share of the tax, unless the decedent’s will directs otherwise (IRC § 2206). The statute limits that rule for proceeds that pass to a surviving spouse and qualify for the marital deduction.

Revocable and irrevocable trusts as beneficiary

A revocable trust named by an insured who owns the policy. The power to change the beneficiary is an incident of ownership (Treas. Reg. § 20.2042-1(c)(2)). An insured who owns the policy and names a revocable trust still holds that power, so the proceeds are in the gross estate under § 2042(2). Property the insured transferred to a trust that the insured could alter, amend, revoke or terminate at death is also included (IRC § 2038(a)(1)).

An irrevocable trust that owns the policy. If the insured held no incident of ownership at death, no part of the proceeds is included under § 2042 (Treas. Reg. § 20.2042-1(c)(1)). This is the structure described on the ILIT page. Two conditions matter. An insured who, under the terms of the policy, has the power, as trustee or otherwise, to change the beneficial ownership of a policy held in trust is treated as holding an incident of ownership, even with no beneficial interest in the trust (Treas. Reg. § 20.2042-1(c)(4)); see incidents of ownership. And a policy the insured gave away within three years of death is included as if it had been kept (§ 2035(a) and (d)); see the three-year rule.

A trustee bound to pay the estate’s charges. The regulation applies to any beneficiary, a trustee included. Where the proceeds are subject to an obligation, legally binding on the beneficiary, to pay taxes, debts or other charges enforceable against the estate, the amount required to pay those charges in full is included in the gross estate, to the extent of the obligation (Treas. Reg. § 20.2042-1(b)(1)). Read with § 2042(1), this means a trust instrument that requires the trustee to pay the insured’s estate tax or debts brings that much of the proceeds into the estate, even when the insured held no incident of ownership.

Income tax on the proceeds

Gross income does not include amounts received under a life insurance contract if they are paid by reason of the death of the insured, whether in a single sum or otherwise (IRC § 101(a)(1)). The paragraph is written in terms of the amounts received, not the kind of recipient. On its terms it applies to proceeds paid to a trustee as it does to proceeds paid to an individual.

The statute states its own exceptions. They include a policy transferred for valuable consideration (§ 101(a)(2)), covered on the transfer-for-value page, and certain employer-owned contracts (§ 101(j)).

Two rules apply when the insurer holds the proceeds after death:

• Interest. If an excluded amount is held under an agreement to pay interest on it, the interest payments are included in gross income (§ 101(c)).
• Payments at a later date. If the insurer holds the proceeds under an agreement to pay them at a date or dates later than death, the amount held is prorated over the payment period. The prorated amount is excluded from the beneficiary’s income, and the rest of each payment is included (§ 101(d)).

Minor beneficiaries

When a minor is named directly, who may receive and manage the money on the minor’s behalf is a question of state law and of the insurer’s contract. The answer differs from state to state.

Naming the trustee of a trust for the child changes the payee. The insurer pays the trustee, and the trust instrument states how the money is used for the child and when the child receives it. Custodial accounts, a different arrangement for a minor’s property, are described on the gifts-to-minors page.

Where trust designations fail

Each of these is a mismatch between the form on file with the insurer and the plan the trust was meant to carry out.

• The trust named does not exist. A form may name a trust that was never signed, or describe it by a name or date that matches no document. The insurer then has no trustee to pay. What happens to the proceeds depends on the policy’s terms and state law.
• The form names the estate. Proceeds payable to the estate are included in the gross estate under § 2042(1), and they pass under the will or the state’s intestacy rules rather than under a trust.
• An earlier designation is left in place. Signing a trust does not change a beneficiary form. If the form still names a person, the insurer pays that person.
• A former spouse is still named. The Supreme Court noted in 2018 that 26 states had adopted revocation-on-divorce laws substantially similar to the Uniform Probate Code provision that revokes a beneficiary designation to a former spouse (Sveen v. Melin). A statute of that kind is pre-empted to the extent it applies to an ERISA plan, as discussed below.
• The policy was transferred shortly before death. A policy the insured gave to an irrevocable trust within three years of death is included in the gross estate (§ 2035(a)).
• Community property. State law decides whether a policy or its proceeds are community property. The estate-tax regulation follows that result. Where proceeds payable to the estate are community assets and half belongs to the surviving spouse, only half is treated as receivable by the estate (Treas. Reg. § 20.2042-1(b)(2)). The regulation also gives an example of a policy bought with community funds, in which the insured is treated as holding an incident of ownership in only half of the policy (Treas. Reg. § 20.2042-1(c)(5)).

Employer and federal group life insurance

Group life insurance provided through an employer can be subject to federal rules that individually owned policies are not. A plan an employer maintains to provide benefits in the event of death, through the purchase of insurance or otherwise, is an employee welfare benefit plan under ERISA (29 U.S.C. § 1002(1)). Subject to the exceptions in § 1144(b), ERISA supersedes state laws insofar as they relate to a covered plan (29 U.S.C. § 1144(a)). A plan fiduciary acts in accordance with the plan documents, insofar as they are consistent with ERISA (29 U.S.C. § 1104(a)(1)(D)).

• In Egelhoff v. Egelhoff, 532 U.S. 141 (2001), which involved an employer-provided life insurance policy and a pension plan, the Court held that ERISA pre-empts a state statute revoking a spouse’s beneficiary designation on divorce, to the extent the statute applies to ERISA plans.
• In Kennedy v. Plan Administrator for DuPont Savings and Investment Plan, 555 U.S. 285 (2009), which involved a savings and investment plan, a divorce decree divested the former spouse of her interest but the participant never changed the designation. The Court held that the plan administrator did its duty under ERISA by paying her in conformity with the plan documents. It expressed no view on whether the estate could have sued her for the benefits after they were distributed.
• Federal employees’ group life insurance is paid in a statutory order of precedence. The designated beneficiary comes first, unless a divorce, annulment or legal-separation decree, or a court order or court-approved property settlement incident to one, expressly provides otherwise and was received before death by the employing agency or, for a separated employee, by the Office of Personnel Management, and a designation made in a will or other document that was not signed, witnessed and filed as the statute requires has no force or effect (5 U.S.C. § 8705(a), (e)). In Hillman v. Maretta, 569 U.S. 483 (2013), the Court held that the federal statute pre-empts a Virginia provision that made a former spouse who received the proceeds liable for them to the person who would have received them under the state’s revocation-on-divorce rule.

Whether a trust may be named under a group plan, and how, is set by the plan’s documents. The cases are discussed more fully on why beneficiary designations override wills. Choosing an owner for a policy is a separate question, covered on who should own the policy.

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