Many parents intend for their life insurance proceeds to be used for
their children’s maintenance, education, medical expenses and
general welfare after their passing. For this reason, they may set up a
testamentary trust in their Will so that the Trustee can manage the
funds until the child reaches a suitable age.
However, one important issue is often overlooked: the policy
nomination.
Common Misunderstanding
Many people assume that once a trust is written in the Will, the
insurance proceeds will automatically enter the trust.
However, if the insurance policy already has a valid nomination, the
insurance company may pay the proceeds directly to the nominee. As
a result, the proceeds may not fall into the estate, may not pass
through the Will, and may not enter the testamentary trust.
Why This Matters?
A testamentary trust can only manage assets that actually enter the
trust.
If the insurance proceeds are paid directly to the nominee, the Trustee
may not receive the funds and may not be able to use them according
to the trust terms.
The intended funding route should be:
Insurance Proceeds → Estate → Will → Testamentary Trust →
Beneficiaries
If the nomination is not aligned, the actual route may become:
Insurance Proceeds → Nominee directly → Trust does not receive
the funds
Practical Reminder
Imagine parent has set up a Will and testamentary trust for the child,
intending the insurance payout to be used for the child’s living
expenses and education.
However, the insurance policy still has a valid nomination. Because of
this, the insurance company may pay the insurance payout directly to
the nominated person. As a result, the money may not form part of the
parent’s estate, may not be dealt with under the Will, and may not go
into the trust. The trustee may then be unable to use the money for the
child as originally intended.
If the client intends to use insurance proceeds to fund a testamentary
trust, the policy nomination should be reviewed carefully.
Key points to confirm:
1. Does the policy already have a nomination?
2. Who is the current nominee?
3. Is the nominee intended to receive the proceeds personally?
4. Or should the proceeds be used to fund the testamentary trust?
5. Does the Will clearly distribute the relevant assets into the
trust?
Using Insurance Proceeds as Funding for a Testamentary Trust
vs Insurance Trust
An insurance trust is usually set up during one’s lifetime, so that
when a claim event occurs, the insurance proceeds will be paid
into the trust according to the trust document, and received,
managed and distributed by the Trustee.
Compared to a testamentary trust, an insurance trust can usually
reduce the impact of probate or estate administration procedures
on the release of funds. This allows the funds to enter the trust
arrangement in a more direct and timely manner.
In simple terms, using insurance proceeds as funding for a
testamentary trust focuses on allowing the Trustee to distribute
funds in the future, either monthly or as needed.
An insurance trust, on the other hand, focuses on allowing the
insurance proceeds to enter the trust more directly, so that the
Trustee can manage and distribute the funds according to the trust
document.
If insurance proceeds are intended to be the main funding source of
the testamentary trust, the nomination arrangement must be aligned
with the Will and trust structure. Otherwise, even a well-drafted trust
may fail to operate effectively because the funds never enter the trust.
It is advisable to seek guidance from a professional estate planner or
lawyer to ensure the estate planning arrangement can be carried out
smoothly.
Every family and every case may be different. Therefore, proper advice
should be taken on a case-by-case basis.
Stay tuned — we’ll be sharing more on the key differences between an
Insurance Trust and a Testamentary Trust funded by insurance payout.
