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Estate Planning Options for Married Couples

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November 13, 2017

Client Alert
If you have created an estate plan but have not revisited that plan in the last five years, it is time to do so. In addition to changes in life, changes in the estate tax rules over the last decade have altered the planning options available for many married couples. If the federal estate tax laws are actually repealed by the current Congress, these options will be relevant for all married couples. The purpose of this client alert is to highlight the typical options for how spouse’s plan for each other in light of the current and potentially changing estate tax rules.

Shelter Trust Planning

When the federal estate tax exemption was significantly lower, many married couples needed to create a trust, when planning for each other, if they wished to avoid or at least minimize federal and state estate taxes. We will refer to this type of trust as a “Shelter Trust.” With the changes in tax rules, most married couples whose net worth is less than $11,000,000 do not need a Shelter Trust to avoid or minimize federal estate tax. However, a Shelter Trust may still be the best option since a well drafted Shelter Trust can provide many non-tax advantages, as discussed below. Additionally, depending on a couple’s residency, a Shelter Trust may still be needed to reduce or minimize state estate taxes. For example, a couple residing in Illinois, whose combined net worth is close to or more than $4,000,000, should still have Shelter Trust planning in order to reduce or eliminate the Illinois estate tax.

Impact of Having A Shelter Trust

To be effective, a Shelter Trust for a spouse must have some restrictions and has to be administered properly. 

Restrictions. There is flexibility in setting up the terms of the Shelter Trust. However, the Shelter Trust has to be restricted enough so that the surviving spouse is not consider the “owner” of the trust assets for estate tax and property law purposes. Terms of the Shelter Trust for a surviving spouse can include: 

Administration. During the surviving spouse’s lifetime, all assets of the Shelter Trust have to be segregated and maintained in the name of the Shelter Trust and the Shelter Trust must file its own income tax returns. Depending on the terms of the Shelter Trust, the amount of distributions to the surviving spouse, and the surviving spouse’s income tax bracket, the income tax paid by the Shelter Trust could be at a higher rate than the surviving spouse’s income tax rate. 

Tax and Non-Tax Benefits of Shelter Trust. A properly prepared and administered Shelter Trust uses one spouse’s estate tax exemption to shelter the trust assets from future estate taxes. A properly prepared and administered Shelter Trust has a number of non-tax benefits as well. 

Options for Married Couples

Married couples have three typical options for how they leave property to each other: (1) outright, (2) a “disclaimer” Shelter Trust, or (3) a full Shelter Trust. Below is a summary of the pros and cons of each of these options.

Outright – with this option, no Shelter Trust is created. All property will pass directly to the surviving spouse (either by beneficiary designation, joint ownership or by naming the surviving spouse as beneficiary of a trust with full or unrestricted rights and powers).

Pros 

Cons 

Who is this type of planning appropriate for? Couples with a net worth that is well below the federal or state estate tax exemption amount, who are unlikely to grow that net worth and who do not care about the non-tax benefits of a Shelter Trust. 

Disclaimer Shelter Trust – with this option, all property will pass directly to the surviving spouse as with the outright option but, if the surviving spouse disclaims (a legal refusal to accept) some portion or all of the assets, the estate plan is set up so that the disclaimed property goes into a Shelter Trust.

Pros

Cons

Who is this type of planning appropriate for? Couples who want flexibility in their estate plan to adopt a Shelter Trust only if needed for estate tax planning, who do not care about the non-tax benefits of a Shelter Trust, and who are less concerned about the surviving spouse having the flexibility to re-direct the distribution of the Shelter Trust to others if a Shelter Trust is created for tax planning. 

Full Shelter Trust – with this option, some defined portion or all of the property of the first spouse will pass directly to a Shelter Trust.

Pros

Cons

Who is this type of planning appropriate for? Couples who will likely be subject to federal or state estate tax or couples who want the non-tax benefits of a Shelter Trust, especially the flexibility for the surviving spouse to re-direct the distribution of the Shelter Trust to a specified group of beneficiaries, such as children and charity. These non-tax factors are often relevant for (a) couples whose children are still fairly young and whose net worth is still growing, (b) couples who have children from a prior marriage, and (c) couples who have very specific desires regarding where the property is distributed when both spouses are deceased. 

If you have not reviewed your estate plan in a while or you have not created an estate plan yet, please contact us to discuss the best estate plan for your circumstances and needs.

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