There are circumstances under which it is advisable to have life insurance proceeds administered by a trustee. A trust can serve many useful purposes, but it is especially desirable when there is a need for great flexibility in the administration of the proceeds or when some of the beneficiaries are minors. It is a common practice for a parent to designate his or her spouse as primary beneficiary and to designate a trustee as contingent beneficiary to administer proceeds for the benefit of minor children. The trustee may be a natural person or a corporation, and the designation may be revocable or irrevocable.

It is essential that a trust agreement exists at the time the trustee is designated beneficiary. If the insured should die before instructions have been provided to the trustee, the trust would undoubtedly be dissolved as unenforceable. In such cases the courts have held that since there is nothing to guide the trustee as to the purpose or manner of distribution of the trust estate, the funds must be paid over to the person or persons presumably entitled to them. If the distributees were children, the proceeds would be paid to duly appointed guardians.

When a trustee is designated as beneficiary, it is usually intended that the trustee will collect the proceeds in one sum and administer them in accordance with the terms of the trust agreement. There are occasions, however, when the trustee deems it advantageous to make use of the insurance company�s deferred-settlement options. Under these circumstances it becomes important to determine whether the trustee has the right to select such options.

Trustees as a class first developed a real interest in insurance policy settlement options in the 1930s, when the going interest rate on new investments dropped below the rate of return guaranteed in insurance company settlement options. Many companies, feeling that trustees were attempting to shift their investment responsibilities (for which they were compensated) to the life insurance industry, and having other reservations about the practice, refused to honor settlement option elections by trustees. When litigation in 1939 established the right of a trustee to elect a settlement option unless that right is denied in the insurance policy, many insurers inserted a prohibition in their policies against the use of settlement options by trustees. Today, however, few insurers continue that practice. Some policies stipulate that the power of all beneficiaries to select settlement options is subject to the insurer�s consent. Others do not limit the rights of natural persons to select settlement options but reserve the right to deny the selection of settlement options to nonnatural persons (trusts and corporations).

In the absence of express permission in the trust instrument, there is a serious question whether a trustee has the legal right to use settlement options, even though the insurance company makes them available. It is standard practice therefore to include proper language in the trust agreement giving trustees the right to exercise ownership powers over life insurance policies. Absent such a clause, the issue hinges on whether or not a life insurance settlement option is a legal investment for a trustee. When the investment statute is the "prudent man" type, a strong argument can be made in favor of the legality of the practice. Many legal experts have concluded, however, that a trustee has an unquestioned right to elect a settlement option only when (1) the trust instrument expressly confers the right, and (2) the insurance policy does not deny the right.