estate planning chapter 24
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Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 1
Marital Deduction & Bypass Trusts “A-B Trusts”
• Gives surviving spouse full use of family’s wealth• Minimizes total federal estate tax payable at the death
of both spouses• Usually eliminates federal estate taxes at the death of
the first-to-die of the spouses by capitalizing on the coupling of the:– Marital deduction– Unified credit
• Avoid overqualification for the marital deduction because of underutilization of unified credit of the first spouse to die
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 2
Unified Credit Schedule
GIFT TAX UNIFIED CREDIT ESTATE TAX UNIFIED CREDIT
Exemption Unified Exemption Unified Year Equivalent Credit Year Equivalent Credit2002-2009 $1,000,000 $345,800 2006-2008$2,000,000 $ 780,8002010 $1,000,000 $330,800 2009 $3,500,000 $1,455,8002011 $1,000,000 $345,800 2010 N/A N/A
2011 $1,000,000 $ 345,800
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 3
How It Works• A-B Trust Plan
– Fund the bypass trust with amount equal to remaining unified credit exemption equivalent amount
• Tax on these assets will be offset by the unified credit• Bypass trust assets and their appreciation will not be taxed again for
estate purposes at the surviving spouse’s death• Spouse typically receives income for life from these assets• Spouse may also be given a limited power or power to take the greater of
$5,000 or 5% of the trust principal– Fund the marital trust with the balance of the estate
• Marital trust assets pass estate tax-free to the spouse using the unlimited marital deduction
• Marital trust assets will be taxed at the surviving spouse’s death
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 4
How It Works (cont’d)
• A-B-Q Trust Plan– Works the same way as the A-B trust plan, except all
or a portion of the assets passing to the surviving spouse may be held in a trust known as a qualified terminable interest property (QTIP) trust
• In a QTIP trust, the surviving spouse gets income for life, but the first spouse to die controls where the property goes after the second spouse’s death
• Often the surviving spouse is given a limited power of appointment over the assets in the QTIP trust to appoint differing amounts to the various predetermined beneficiaries
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 5
• Other types of marital trusts– General power of appointment with mandatory income to
spouse: Surviving spouse can appoint the property to whomever the spouse wishes including himself, his creditors, his estate, or the creditors of his estate
– Estate trust: Mandatory income to surviving spouse and remainder passes to spouse’s estate at spouse’s death
How It Works (cont’d)
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 6
– Created during grantor’s lifetime– Can be torn up or changed anytime during life– Trustee of life insurance trust is named beneficiary
of life insurance issued on grantor’s life– Will provision that states grantor’s residuary estate
(net payment of debts, expenses, taxes and specific bequests) be “poured over” into the life insurance trust
Revocable A-B-Q plan with life insurance trust coupled with a “pour over will”
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 7
• After funding, the trust is divided into two or three parts:– Marital or “A” Trust– Bypass “B” or Family Trust– QTIP Trust
• Trust provides flexibility, while minimizing taxes and meeting long term family goals
Note: The revocable trust may hold other assets besides life insurance, prior to grantor’s death, in order to avoid probate for those assets. All of the trust assets will still be included in the grantor’s gross estate for the estate tax calculation.
Revocable A-B-Q plan with life insurance trust coupled with a “pour over will” (cont’d)
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 8
Spouses desire:1. Survivor to have full economic benefit (not ownership) of
family’s wealth, and2. Minimize the aggregate death taxes payable at the death of
both spousesWant to avoid overqualification of assets for marital deduction (Don’t want to waste the unified credit of first spouse to die)
Where couples plan to set up generation-skipping transfer trustsFavorable state inheritance tax may be obtained
When Is The Use Of A Marital Deduction & Bypass Trust Appropriate?
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 9
• Management of trust property is needed for surviving spouse or other beneficiaries
• Desire to avoid probate• One spouse is a non-U.S. citizen• First spouse to die wants to benefit surviving spouse
and ensure that remaining assets will go to children• Desire flexibility until the first spouse’s death whether
to pay some estate tax at that time
When Is The Use Of A Marital Deduction & Bypass Trust Appropriate? (cont’d)
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 10
In General:– Assets in the marital trust must pass to or be held for the
benefit of the person married to the decedent at the time of decedent’s death
– In documents creating the marital trust, insert a survivorship clause creating a presumption that for purposes of the marital deduction the spouse is deemed to have survived in the event of a simultaneous death
What Are The Requirements?
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 11
Power Of Appointment Trust:1. Surviving spouse right to all income produced by the trust
2. Income produced by trust payable at least annually
3. Surviving spouse given general power of appointment during life, at death, or both
4. Power exercisable by surviving spouse in all events
5. No person has power to appointment any part of trust to
anyone other than surviving spouse
What Are The Requirements? (cont’d)
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 12
Estate Trust:1. Income to surviving spouse for life (payable to, or
accumulated for, surviving spouse’s benefit)2. Remainder of trust (principal + accumulated income) payable
to surviving spouse’s estate at surviving spouse’s death
When to Use:– Desire or need to invest in non-income producing property– Survivor will not need trust assets or income during survivor’s
lifetime, and– Property placed in trust is not likely to appreciate substantially
in value
What Are The Requirements? (cont’d)
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 13
QTIP Trust:1. All income payable to surviving spouse at least annually2. Trust does not need to grant surviving spouse power of
appointment3. No power to shift any of the trust property to anyone other than
surviving spouse during spouse’s lifetime4. Spouse power to require trustee to make the assets produce
income5. Executor must elect QTIP treatment on decedent spouse’s
estate tax return
What Are The Requirements? (cont’d)
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 14
QTIP Trust (cont’d)When to Use:– Desire amount in excess of unified credit exemption
equivalent to qualify for the marital deduction at the first spouse’s death
– Do not want surviving spouse to hold a general power of appointment over marital trust assets
What Are The Requirements? (cont’d)
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 15
Electing to Pay Some Tax
• Tax savings can be realized by paying taxes early if property increasing in value
• If asset is worth $100,000 at first spouse’s death and expected to appreciate to $500,000 by second spouse’s death, may be better to pay estate tax on $100,000 rather than on $500,000
• This is where a QTIP and disclaimer provisions and elections can add some flexibility in estate tax planning
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 16
Reverse QTIP Election
• For 2006-2009, the generation-skipping exemption equals the federal estate tax unified credit exemption equivalent– In the typical A-B plan, the bypass trust will receive the full
GST allocation– If no lifetime gifts have been made, no reverse QTIP is
necessary– If gifts have been made during lifetime, GST exemption and
estate tax unified credit exemption equivalent may be unequal at death
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 17
• QTIP election qualifies transfer from decedent spouse to surviving spouse for estate tax marital deduction– QTIP property will be included in surviving spouse’s estate
• With reverse QTIP election, decedent spouse treated as transferor for generation-skipping transfer tax purposes– Avoid waste of GST exemption of first spouse to die where
GST exemption and estate tax unified credit exemption equivalent are unequal at death
Reverse QTIP Election (cont’d)
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 18
Issues In Community Property States
• Remember ½ of the property already belongs to the surviving spouse– This property is usually not subject to the provisions of
decedent’s will – If spouse elects to retain their ½ interest in property, then
management of the property is split with trustee of the marital trust
– If spouse’s property passes through decedent’s will, then it usually pours into a power of appointment marital “A” trust
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 19
• Owning property as joint tenants with right of survivorship or as tenants by the entirety between spouses will cause the property to pass outside of the decedent’s probate estate and not be available to fund the bypass “B” family trust– May result in underutilization of first spouse’s exemption– Property passing to surviving spouse tenant will qualify for the
marital deduction
Jointly Owned Property
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 20
• If trusts are currently funded, trustee fees may need to be paid– Avoid trustee fees by grantor acting as trustee
• After death of grantor, surviving spouse cannot have unlimited control or access to assets in nonmarital trust(s)– Give spouse mandatory income at least annually– Give trustee discretion to distribute principal to surviving
spouse per an ascertainable standard– Give spouse 5 or 5 withdrawal power– Give spouse limited testamentary power of appointment
Disadvantages of A-B/A-B-Q Trust
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 21
• Estate trust does not require all income to be paid out to surviving spouse, some can be accumulated in the trust
• May make it easier to retain non-income producing assets in the trust
Advantages of Estate Trust vs. Power of Appointment Trust
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 22
Advantages of Marital Deduction Passing to QTIP Trust
• Flexibility for trustee to determine how much of the trust should be taxed at the death of the first spouse
• Grantor can be certain that at the death of the surviving spouse, property will go where grantor wanted it to go, not to survivor’s new friend or spouse
• Only optimum marital arrangement allowing:– Grantor’s full GST exemption to be preserved, while– Property still benefits surviving spouse during life, and– No estate tax is due at grantor’s death
Marital Deduction and Bypass Trusts
Chapter 24Tools & Techniques of
Estate Planning
Copyright 2006, The National Underwriter Company 23
• It depends on the type of assets the grantor owns– If probability of substantial increase in value during settlement
period of trust or estate Pecuniary formula clause giving residual amount to the bypass trust
– If possibility of drop in estate value Pecuniary formula specifying exact amount to bypass and residual to marital trust
– Fractional share clause• Avoids recognition of income tax gain upon transfers to a trust
• Shifts increase or decrease proportionately to both marital deduction and bypass trusts
Which Funding Formula Is Preferable?