Generally, an insured cannot be the trustee or co-trustee of a TOLI because it usually results in an incident of ownership, which results in potential estate tax inclusion. An incident of ownership arises when the insured receives an economic benefit from the policy; for example, when the insured has the power to change beneficiaries, take loans from the policy, surrender the policy, cancel the policy, or can assign or cancel the assignment of the policy.
It is also not advisable for the settlor’s spouse to be the trustee, although it is possible as long as the trust does not own any insurance on the life of the spouse (including a second-to-die policy), and the spouse, as trustee, does not have powers that will result in a general power of appointment. Otherwise, the TOLI will be included in the spouse’s estate at the spouse’s death
A spouse will have a general power of appointment under the following situations: (1) when the spouse can make discretionary distributions to themself without limiting such distributions by an ascertainable standard (e.g. for health, education, support); (2) when the spouse can make distributions that discharge a support obligation of the spouse; or (3) when the spouse fails to prevent distributions to their creditors or estate. If the spouse accidentally breaks one of these rules while acting as trustee of the TOLI, insurance proceeds will be included in the taxable estate. Also, remember that the TOLI cannot be funded with community property if the spouse is a beneficiary.
Therefore, it is advisable to have an outside party, such as a trusted relative, friend, advisor (such as a Lawyer/CPA), or company offering trustee services to act as trustee to ensure compliance.
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