Pitfalls of Serving as Trustee for Client’s Life Insurance Trust

Trusts are a tremendous life insurance selling tool. Many clients aren’t interested in giving a multimillion-dollar cash gift outright to their children and other beneficiaries. A life insurance trust gives them the control they need to satisfy themselves that a life insurance policy is the right estate planning solution for themselves and their families. But control comes at a price; a trustee must be appointed.

Once you’ve shown your clients how a life insurance policy held in trust is the right solution for their particular problems, how do you handle the conversation about appointing a trustee?

You must first review the advantages of life insurance trusts and how they help  solve your clients’ biggest estate planning concerns. Then  examine the advantages and disadvantages of agreeing to serve as trustee of your clients’ life insurance trusts. This will provide a roadmap for analyzing whether serving as trustee is the right decision for you, your business, and your clients.

The Life Insurance Trust Advantage

Bare life insurance offers insureds the opportunity to name who will receive the policy proceeds, but stops short of giving control over when and how funds will be disbursed. Retained asset accounts go a step further by specifying when proceeds will be paid, but only life insurance trusts offer insureds nearly absolute control over policy proceeds.

Trust beneficiary language gives the insured far greater precision over who will receive payouts than a simple beneficiary designation; an insured has a much higher degree of flexibility when naming beneficiaries of a life insurance trust as opposed to beneficiaries of a life insurance policy.

Another benefit of a trust over a bare policy is that the insured can assert post-mortem control over which proceeds will be distributed to beneficiaries. For instance, the trust instrument can specify that the insured’s children will receive disbursements from the trust only if they graduate from college.

For many clients, a life insurance trust is an essential tool for managing a policy because of its ability to remove the policy from the insured’s estate for income tax purposes and permit the insured to leverage gift and GST tax exemptions to provide their beneficiaries with a high-dollar transfer-tax-free gift.

A trust’s ability to give your clients control over the who, when, and how and to mitigate the transfer taxation of a life insurance policy can make your job easier. But what do you do when the inevitable happens, and your clients ask you to serve as trustee of their life insurance trust? Make your decision with an awareness that serving as trustee may not be worth the goodwill it engenders with your clients.

The Pitfalls of Serving as Trustee of a Life Insurance Trust

Trustees can be the cement that holds together long-term client relationships, making the job ideal for producers who understand the importance of staying active in their clients’ financial lives. But serving as trustee is serious business, with risks and consequences that must be weighed carefully:

• Trustees are charged with managing trust assets, including investments and life insurance policies.
• Investments must be reviewed periodically to determine whether they are appropriate to the purpose of the trust, with an eye toward capital preservation and reasonable income.
• But what standard is applied when a trust holds a life insurance policy? Laymen think of a life insurance policy as a buy and hold proposition that won’t pay off until the insured’s death, but the reality is that trust-owned life insurance is a minefield for trustees.

A trustee’s job is difficult enough, but when the trustee is also the insured’s insurance agent or broker, other issues come into play that increase the trustee’s risk. 

Fiduciary Duty

Brokers and insurance producers have a duty to provide  clients with recommendations that are suitable to the client’s circumstances. In contrast to this intermediate standard of care, trustees are subject to the highest standard of care, the fiduciary standard, when acting on behalf of the trust.

A serious issue for a trustee in the insurance business is the conflict of interest rules under the fiduciary standard. Generally, a trustee must not enter into transactions with the trust that present a conflict of interest. If a policy must be replaced, conflict of interest issues arise for the trustee if the trustee also acts as the insured’s insurance agent in the transaction. Although the trust instrument can waive conflicts of interest to some extent, whether the waiver is effective depends on its breadth and the laws of the jurisdiction where the trust is situated.