Disclaimer trusts – what are they? how do they work, and should you have one?

When I consider the effect of the 2011 changes in federal estate taxes I see some brand new reasons for my married clients to replace their Marital A-B trusts with Disclaimer trusts.

The reasons to choose, or to switch to, a Disclaimer trust include increased flexibility in estate tax planning and the possibility for more liberal access to joint assets for the surviving spouse.  On the negative side, this type of trust does require the surviving spouse to take action within nine months of the death of the first spouse to die.  It’s not an ideal time for many people make major decisions.
Before I explain the difference between the trusts, let me explain a couple key concepts:
Unlimited Marital Deduction – There is no limit on the assets that you can leave your spouse without paying estate tax.  When   you calculate taxable estates, the property that goes to a surviving spouse is excluded.
Estate Exclusion Account – There is a limit on the amount of assets that can be left to a non-spouse, or to your children, without paying estate tax.  The purpose of most estate trusts it to maximize the amount you can pass on without paying estate tax.
It’s the later, the Estate Exclusion Amount, that has been jumping around since 2001 like a jumping bean.  It’s currently in hibernation mode at $5.0 million.  Will that limit make a difference if you don’t have a $5.0 million estate?  Definitely – if you have an A-B, or Bypass Trust written prior to 2001, when the estate exclusion amount was only $1.0 million.
If that is the case, the amount that can be set aside to “bypass” estate taxes is probably limited to the lower $1.0 million exclusion amount. You would not be taking advantage of the new exclusion of up to $5.0 million.  If you have Marital A-B trusts, you may be leaving your spouse with insufficient assets.
Here’s how the marital A-B trust works:  Assume that a couple has $2.0 million in assets, a $1.0 million residence and a $1.0 million in rental properties and investments. The husband dies first.  The trust document specifies that the home will go into the “A” trust, often referred to as the Spousal trust.  The surviving spouse can do what she wants with this trust and its assets.  It’s revocable.  The rental properties and investments go into the “B” trust or the Bypass trust which is irrevocable.  You can’t change the trust or the beneficiaries.  It’s protected and she has limited access to the principal.  Perhaps the home is not paid off.  Now she owns the home, may be she is not working and she is dependent on the income to live.  In today’s market, would you want her budget?
I know your next question is how much does she owe on her home?  You’re right she might be O.K.  My point is that you need to review your trust to assume if it still works for you.  Perhaps that portfolio is now only worth $500,000.   Different financial circumstances require different solutions.  So what might be another choice – a Disclaimer trust?   With a Disclaimer trust, it is up to the surviving spouse to decide how much of the joint assets will bypass taxes.  Whatever that amount is, the surviving spouse “disclaims it,” providing the spouse with a lot more flexibility in taking the principal she or he needs.  Crafted correctly, a Disclaimer trust will give the surviving spouse use of the marital assets, and the couple still gets to pass on $5.0 million to their children without paying estate taxes.
Obviously, trusts like these are very complicated and require the use of a qualified attorney.  But before you see your attorney, it could make sense to see your hourly financial planner.
If you are unsure what you’re estate is worth, or how much you might need to support yourself, an hourly financial planner can help you balance present needs with future requirements.  I would be happy to help you identify your net worth, project your income and show you the impact of your financial choices, including the very important choice of a spousal trust.

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