Do you plan on leaving anything to your spouse after you are gone? If you do, you have lots of options. There are many ways to leave an inheritance to your spouse. Most married couples, especially long-term married couples, have what I call the “Honey I love you” plan, which is “Honey I love you, I leave it all to you. Our beneficiaries get it after we are both gone.” This is the type of plan that I have.
However the way that you leave it to your spouse can have a huge impact on not only your spouse, but on the other beneficiaries. The four most common ways that I have seen used to leave an inheritance to a spouse are outright distribution, convenience trust, family trust and marital trust.
Outright Distribution.
You and your spouse may have one of the most common type of estate plans between married couples which are simple wills leaving everything to each other. With this type of plan, you leave all of your assets outright to your surviving spouse. The kids or other beneficiaries only get something after you are both gone. This type of plan may initially seem attractive to you because it is fairly simple and economical to draft. However, there are disadvantages.
Firstly, all of the assets you leave to your spouse are available to satisfy claims against your spouse from lawsuits, bankruptcies, creditors and others. If after your death, your surviving spouse marries Thor or Bambi, and then predeceases Thor or Bambi, who is often much younger spouse, Thor or Bambi may have a claim against your assets. Or your surviving spouse could make everything joint with Thor or Bambi which would disinherit all of your other beneficiaries.
Secondly, any assets that are in your sole name at the time of your death would need to go through the probate court process 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.
Thirdly, if you or your spouse do not also have properly drafted financial powers of attorney and you or your spouse became incapacitated, then you or your loved ones may have to petition the probate court for a court supervised conservatorship to pay bills, sell property or to protect assets in the event of a nursing home admission.
Convenience Trust.
A common alternative to outright distribution of an inheritance to your spouse is to set up a fully-funded lifetime convenience trust for your spouse. This trust is also called a general power of appointment trust. Trust funding is completely and correctly designating your trust and individuals as owners, beneficiaries and insured parties of your assets. Basically, it’s putting your stuff in your trust.
The proper funding of your trust is critical in making your estate plan work and having the results you plan. Failure to properly fund your trusts may cause unintended results. These may include probate during your lifetime or after death; distributions not in accordance with your goals and objectives; additional taxes; and additional administrative, legal and other expenses..
With a convenience trust, you avoid two of the four pitfalls of outright distributions. You no longer would need to have a probate court supervised conservatorship upon you or your spouse’s incapacity for those assets in the trust and similarly probate court estate administration is avoided upon your and your spouse’s deaths.
In your convenience 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. This is called a limited power of appointment. I also call it the “power of disappointment” because after your death, your surviving spouse can disinherit the kids.
What are the risks of a convenience trust? A convenience trust does not offer protection for claims against your spouse from lawsuits, bankruptcies, creditors or others. Upon your remarried surviving spouse’s death, their new spouse Thor or Bambi may also have spousal claims against your assets that you left to your surviving spouse in this type of trust.
Family Trust.
A more beneficial but not as common 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. You can use this type of trust even if you do not have a taxable estate. After you are gone, during your spouse’s lifetime, he or she gets income or principal whenever needed for health, education and maintenance, basically for your surviving spouse’s needs.
As with a convenience trust, the assets in this type of trust avoid probate upon your or your spouse’s incapacity or death and you can have a power of disappointment provision. In addition, your spouse’s inheritance is protected from claims against your spouse from lawsuits, bankruptcies and creditors. Your spouse’s inheritance is also protected from divorce and most death claims from the new spouse, Thor or Bambi.
Furthermore, you can put remarriage protection in your family trust. For example, in my family trust, I put a provision that states that after I am gone, all distributions to my wife Emily stop when she marries Thor, unless Thor signs a pre-nuptial agreement waiving any claims to Emily’s assets. This does two things. It protects our entire marital estate for our children Luke and Elizabeth, and it takes the pressure off of Emily when requesting a pre-nuptial agreement from Thor. She can blame it on me. Well Emily said fair is fair, so she put Bambi protection in her family trust.
If you limit the amount of assets that go into your family trust to the estate tax exemption amount ($5.49 million in 2017), all assets in the trust pass estate tax free not only to your spouse, but to your children or other beneficiaries upon your spouse’s death, even if the assets have substantially increased in value. For example, let’s say you left $3 million in this type of trust for your spouse in 2017 or thereafter 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 $6 million and doubled again to $12 million by year 14. The entire $12 million would pass estate tax free to your children or other beneficiaries.
Marital Trust.
If your estate is in excess of the estate tax exemption of $5.49 million) in 2017, 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 his or her lifetime. Your surviving spouse may also get principal if needed for education and maintenance, for your surviving spouse’s needs.
This marital trust can have all of the benefits and protections of a family trust for the benefit of your spouse. In addition, since it qualifies for a marital deduction, there is no estate tax on the assets upon your death. However, upon your spouse’s death, the assets in this marital trust, are added to your spouse’s taxable estate for estate tax purposes.
Although a simple wills or convenience trusts seem cheap and easy, they 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 through the use of family and marital trusts.
By Matthew M. Wallace, CPA, JD
Published edited February 5, 2017 in The Times Herald newspaper Port Huron, Michigan as: Your options for leaving an inheritance to a spouse