Are you going to leave anything to your spouse when you are gone? If so, there are lots of ways to leave an inheritance to your spouse. If not, you can stop reading now. The four most common ways that I have seen to leave an inheritance to your spouse are outright distribution, convenience trust, family trust and marital trust. What are they and what do they do?
Outright Distribution
You and your spouse may have one of the most common type of estate plans between married persons which is the “Honey I love you, I leave it all to you” plan. With this type of plan, you leave all of your assets outright to your surviving spouse. The kids only get something after you are both gone.
This type of plan may seem attractive to you because it is very simple to draft and is very economical. However, there are disadvantages.
First, all of the assets you leave to your spouse are available to satisfy claims against your spouse from lawsuits, bankruptcies and other creditors. In addition, if your surviving spouse marries Thor or Bambi after your death and predeceases their new and quite often younger spouse, Thor or Bambi may have a claim against your assets. This could limit the amount of assets that are inherited by your children.
Second, since the assets are going directly to your spouse, you forfeited your estate tax exemption. Although there is no estate tax in 2010, there is scheduled to be one in 2011. In 2010, even if Bill Gates died, his estate would pass to his beneficiaries entirely estate tax free. In 2011, the estate tax exemption goes back to only $1 million.
With a “Honey I love you, I leave it all to you” plan, you and your spouse could only pass $1 million estate tax free to your beneficiaries upon the survivor’s death in 2011 or thereafter. With a properly drafted estate plan, you could easily double that to $2 million by using both spouse’s estate tax exemption.
Third, any assets that are in your sole name at the time of your death would need to go through probate in order to get them into your spouse’s name. Your assets will then have to be probated again upon your spouse’s death in order to go to your ultimate beneficiaries. Probate takes time, often a year or more, can tie up your assets during administration and also can be expensive.
Convenience Trust
A common alternative to outright distribution of an inheritance to your spouse is to set up a lifetime convenience trust for your spouse. This trust is also called a general power of appointment trust. By setting up this type of trust and titling or funding your assets into the trust, you avoid probate court supervised conservatorship upon you or your spouse’s incapacity and avoid probate court estate administration upon you or your spouse’s death.
What are the risks of a convenience trust? A convenience trust does not offer protection for claims against your spouse from lawsuits, bankruptcies or other creditors. Upon your surviving spouse’s death, their new spouse Thor or Bambi may have spousal claims against your assets that you left to your surviving spouse in this type of trust. Also, as in an outright distribution, you forfeit your $1 million estate tax exemption to leave assets estate tax free to your children in 2011 or thereafter.
Family Trust
A more attractive alternative is to use an asset protection family trust for the benefit of your spouse. This trust is often called a credit shelter trust or the A trust of an A-B trust. During their lifetime, your spouse gets income or principal whenever they need it for their health, education, maintenance and support.
The assets in this type of trust avoid probate upon your incapacity or death, and in the event of your spouse’s incapacity or death. Your spouse’s inheritance is protected from claims against your spouse from lawsuits, bankruptcies and other creditors. Additionally, your spouse’s inheritance is protected from divorce or death claims from their new spouse, Thor or Bambi.
If you limit the amount of assets that go into this type of trust to the estate tax exemption amount of $1 million in 2011 and thereafter, all assets in the trust pass estate tax free not only to your spouse, but to your children upon your spouse’s death, even if the assets have substantially increased in value. For example, lets say you left $1 million in this type of trust for your spouse and your spouse survived you for 14 years and did not need any amounts in that trust. The trust may have doubled in 7 years to $2 million and doubled again by year 14 to $4 million. The entire $4 million would pass estate tax free to your children.
Marital Trust
If your estate is in excess of the estate tax exemption of $1 million in 2011 or thereafter, you could avoid all estate taxes upon your death by setting up a special marital trust for the benefit of your surviving spouse for all of such excess. This trust is also called a Qualified Terminable Interest Property (QTIP) trust or the B trust of an A-B trust.
With this marital trust, your surviving spouse would receive all the income during their lifetime. Your surviving spouse may also get principal if they need it for health, education, maintenance and support.
This marital trust has most all the benefits and protections of an asset protection family trust for the benefit of your spouse and in addition, since it qualifies for a marital deduction, there is no estate tax on the assets upon your death. The assets in this marital trust however, are added to your spouse’s assets upon their death and are included in their taxable estate for estate tax purposes in 2011 and thereafter.
In your convenience, family or marital trust, you can give your spouse the power after your death, to reallocate the trust assets among your trust beneficiaries or name other beneficiaries of your trust, which would take effect after your spouse’s death. I call this the “children honor your mother (or father) because mom (or dad) can disinherit you after I’m gone” clause. It is also called a limited power of appointment.
Although a “Honey I love you, I leave it all to you” plan may seem efficient, it may not always be the best type of plan to give what you have to whom you want when you want the way you want. You have options to not only provide for your spouse, but also you can provide them with creditor, tax and other protections.
By: Matthew M. Wallace, CPS, JD
Published edited March 28, 2010 in The Times Herald newspaper, Port Huron, Michigan as: Weigh options when leaving spouse inheritance