When you create your estate planning documents, you might see reference to a disclaimer marital trust, which may be referred to as an A/B, “QTIP trusts”, or “Credit Shelter Trust”. These all tend to have similar purposes, so let’s explore how this type of trust may be advantageous to your planning.
Disclaimer language in a trust document allows the named beneficiary, in this case, the surviving spouse, to file a formal notice that they refuse to accept all or part of the bequest made to them by the first to die spouse. Why would anyone want to “disclaim”? This tool is used to allow each spouse to take full advantage of the credit, or tax exemption, each has from estate tax. The estate tax in Maryland is currently effectively 16% and at the federal level is currently, effectively, up to 40%.
A spouse is fully exempt from having to pay federal or state estate tax when they receive a bequest from the first to die. However, if they accept the bequest, this could cause their own estate to balloon beyond the amount they can pass on estate tax free. When the second spouse dies owning assets greater than their allowed credit exemption, the estate will get hit with the hefty estate tax. This means less money will get passed to the next in line: typically the couple’s children.
Therefore, in some case, it makes sense for the surviving spouse to “disclaim” part or all of the bequest of the first to die. The assets then go to a marital trust.
Why Set Up A Marital Trusts
Marital trusts are designed to make use of the marital deduction in tax law. With the martial deduction, no estate tax is due at the first death no matter how much is passed to the survivor. For 2020 each person in Maryland may pass $5 million tax free. For 2020, the federal estate tax credit increased to $11.58 million for an individual and $23.16 million for a couple. Thus, frankly, most people don’t need to worry about disclaiming and taking advantage of a marital trust.
However, who knows what the future will bring. It may be that Maryland and or the federal government decide to lower the tax exemption. This may be a way for government to recoup funds that were distributed as part of the various 2020 stimulus packages. It doesn’t hurt to include disclaimer language in your estate plan so that if the credit is drastically reduced, you don’t need to worry about having an outdated plan.
How does a Disclaimer Marital Trust Work?
The first decedent of the couple sets up language in their estate document, be it their revocable living trust, or last will and testament, which allows the surviving spouse to fund a martial trust for the surviving spouse’s life time benefit. Note that the surviving spouse is the beneficiary of the trust but not the owner of the assets in the trust. This is an important distinction. This keeps those funds from being counted as part of the estate of the second to die. This is what allows those assets to be protected from the estate tax.
The trust is funded with the amount of funds that, if passed to the survivor, would increase the survivor’s tax liability upon their death. When the surviving spouse dies, the final beneficiaries, of any funds that may be left, are those beneficiaries named by the first to die. Typically they are the couple’s children.
The surviving spouse may not change the end beneficiaries. This kind of trust allows the first to die to pass their assets, most often, to their children, while allowing the surviving spouse to have the life time security of being able to use the funds for the survivor’s health, education, maintenance and support.
As you can see, in addition to the potential tax benefit, this type of trust may also be a very useful tool if the couple have children from prior relationships. The first to die is assured that they have taken care of their spouse for the rest of their life, but also know that any remaining funds will go to the first to dies children, not to the survivor’s children or subsequent spouse. While the surviving spouse may be the beneficiary, they are still upheld to a fiduciary standard to make certain that they do not unwisely spend the assets beyond what is needed for their means. Remember the objective is take as much advantage as possible of each spouse’s tax credit to pass as much as possible to their children tax free.