“Do I really need life insurance riders if my policy is held in a trust? Can I even use them?” That’s a question we get from a lot of clients who are considering a new policy and don’t know if it’s worth the additional expense of riders because they plan on holding those policies in a trust. While you can’t change a policy in a trust, there might be ways you can benefit from those policy riders, even when they are held in a trust.
In fact, there are some riders we recommend just as a matter of policy because they cost so little but pay out a lot more in benefits. Depending on your own circumstances, there might be more than a few riders to consider, even if your policy is held in a trust.
Common Life Insurance Riders
A rider on a life insurance policy is a way of getting an additional benefit from a term or permanent life policy. Whether you might need long-term care (LTC) or a reduction in your premium, there are certain riders that can be lucrative in the event that you need them.
Consider the most common rider: the LTC rider. An LTC rider is simply a way of adding long-term disability insurance to your policy by allowing you to take money from the death benefit if you become permanently disabled. About 70% of people over the age of 65 will need LTC at some point, so this one comes highly recommended.
Another rider that goes along with disability-based riders is the “waiver of premium” rider. This is a type of rider that allows your premium to be waived in the event that you become totally disabled. Fewer of our clients need this rider because, usually, they are retired already or are receiving income as a result of a business and their ability to earn money won’t be impacted by a disability. The same goes for any disability income riders, which are designed for people who would not be able to support themselves if they weren’t able to collect a regular paycheck. These riders are generally better for people who are dependent on a weekly paycheck and life insurance is their sole means of passing on money to their heirs.
Riders we recommend to our clients are usually more along the lines of riders designed to preserve your insurability. Common ones are the guaranteed insurability rider and the term conversion rider. The guaranteed insurability rider makes it so additional policies can be purchased on your life without the need for an additional medical exam. The term rider allows you to convert a term policy to a permanent one without the need to go through a medical exam. These riders are usually recommended for people who are older or have health problems that could result in them being uninsurable later on.
Critical illness and accelerated death benefit riders are riders designed to protect you from the worst-case scenario. These riders will advance you a certain portion of your death benefit in the event that you’re diagnosed with a critical — and, in most cases, terminal — illness. These riders can help offset the cost of medical coverage, but at the same time, can deplete your heirs’ benefits, which is why they need to be reviewed on a case-by-case basis.
Will My Riders Work in a Trust?
Riders on a life insurance policy can work within a trust, but some riders will require careful maneuvering to ensure you don’t have any incidents of ownership. Incidents of ownership are areas in which you might have control of the policy and, when you have incidents of ownership, the IRS will consider that policy part of your estate. Generally, if you can take money out of an insurance policy, that’s considered an incident of ownership. So when you have a rider that offers a cash benefit, having that life insurance policy pay you directly will result in an incident of ownership.
Consider the case of a hybrid life insurance policy with an LTC rider. If you become totally disabled and need that LTC rider, consider whether the trust pays for your treatment or pays you directly, since this could create an incident of ownership. To avoid this, the trust could create a separate transaction, making a loan to you. The loan would need to include interest to qualify as a bona fide collateralized loan. The key to this is ensuring the initial benefit of the rider goes to the trust — and not you — to avoid incidents of ownership.
However, this is only the case when you’re using a rider through which you expect to receive cash in your own pocket. In instances in which the trust is using the rider to maintain your insurability, like in a term-to-permanent or guaranteed insurability rider, this process is relatively seamless. The trust isn’t receiving a monetary benefit, but instead, it’s receiving a guarantee of future insurability of the individual it insures. In this case, the rider acts for the benefit of the trust and should work without impacting potential incidents of ownership.
Riders can be a valuable resource in a life insurance policy, even if that policy is held in a trust. Depending on your circumstances, a Howard Kaye advisor may recommend a variety of riders to ensure your trust is able to protect you and your heirs. Call us at 800-DIE-RICH today.
