Living Trusts for Couples

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 significantly changed estate planning for 2011 and 2012.  One of the key changes was to increase the federal estate tax exemption amount from $1 million to $5 million per person.  So, for a married couple, they can theoretically pass a combined $10 million to their descendants without a federal estate tax.  One of the other key changes was to provide for the “portability” or transfer of the exemption from the deceased spouse’s estate to the surviving spouse.  This latter change may reduce some of the incentive to use living trusts.

One of the main reasons for using living trusts is to eliminate or reduce the federal estate tax.  In the past, if each spouse had a living trust and sufficient assets were transferred into each trust up to the exemption amount, the exemption amount of the first spouse to die was fully utilized, i.e., it was not lost.  As a result, the couple was able to maximize the transfer of wealth to their descendants.  This ability to use both exemption amounts has been a critical motivator for traditional A/B trust planning.  The recent addition of the “portability” or transfer of the unused exemption amount to the surviving spouse will likely translate into fewer living trusts for married couples. However, does this mean living trusts are dead for married couples? The short answer is “No.” There are many other good reasons to use living trusts for married couples.

The traditional A/B trust planning will still be needed if the spouses want to designate certain assets for children and other descendants, instead of the surviving spouse.  There is also the issue of control. For example, using the A/B trust planning will help ensure that the assets left in the B trust (or family trust) at the first death will eventually pass to the children and descendants of the couple, and not to any new children or new spouse of the surviving spouse.  This may be more of an issue if there is a significant age gap between the spouses, or if there has been a prior marriage.  Another good reason to consider A/B trust planning is creditor protection. The asset in the B trust (or family trust) can generally be protected from the creditors of the surviving spouse and children.  Another practical reason to consider A/B trust planning is that the current law is set to expire on January 1, 2013, and there is great uncertainty as to what will happen in 2013. Will “portability” survive?  There is not way to know.

One of the most important reasons to use the A/B trust planning model is the generation-skipping tax (GST).  (The GST is that nasty tax which is generally imposed when assets are transferred to grandchildren instead of children.) It should be noted that each person has a $5 million GST exemption.  While the federal estate tax exemption can be transferred to the surviving spouse, the GST exemption is not “portable” and will be lost if it is not used during lifetime or at the death of the first spouse to die.

It should also be noted that in the traditional A/B trust planning model, the assets left in the B trust (or family trust) are not subject to estate tax at the survivor’s death.  So, the assets can appreciate (hopefully) and the appreciation is not subject to further estate tax. On the other hand, if all of the assets are left to the surviving spouse, the appreciation is included in the estate of the surviving spouse and subject to estate tax at that time. This may be an important consideration depending on the total size of the combined estates.

There may be some situations where A/B trust planning is not as important or needed.  If it is overwhelmingly important for the surviving spouse to maintain full control of all marital assets, then A/B trust planning may not be needed. Also, A/B trust planning may not be needed where the couple is in a long-term committed relationship and the only children belong to both of them. Some other factors favoring a simple plan without trusts include: the couple has no real concerns about the possible remarriage by a surviving spouse; the couple intends for their children to be the primary beneficiaries of the estate when both spouses are gone; and asset protection concerns are not important.

In summary, living trusts are not dead as an estate planning tool for married couples, at least not yet.  They may be used less, but they are still very viable and valuable instruments. In light of the changes made by the 2010 Tax Relief Act, I am recommending that those with sophisticated estate plan have those plans reviewed.