The conclusion of my previous post alluded to an estate planning strategy that tries to balance the needs of the surviving spouse and children as trust beneficiaries by taking advantage of the surviving spouse’s disclaimer rights. This post will discuss that technique in more detail.
In my last post I discussed a concern I had about the impact of traditional trust tax planning on moderately sized estates. For example, assume Charlie Client died owning $1,200,000 of assets in his individual named, all of which passed to his trust. If Charlie was survived by his wife and adult children, the traditional trust tax funding formula would allocated $1,000,000 of Charlie’s assets to the family trust for the benefit of his wife and children, and $200,000 to the marital trust for the exclusive benefit of his wife. I expressed concern that this traditional approach can put the surviving spouse at risk with respect to the assets in the family trust since the presence of her children as co-beneficiaries of this trust may give rise to claims from the children that too many trust assets are being spent for the benefit of their mother and/or that the trust’s investment approach was too conservative and biased too much towards income generation.
An alternative approach would allocate all of the trust assets to the marital trust for the exclusive benefit of the surviving spouse and not create or fund the family trust. With careful tax elections, this approach would provide Charlie and his wife with the same estate tax savings.
However, Charlie and his wife might want to consider a third approach that is a hybrid of the first two approaches and provides the same estate tax savings.
Under the hybrid approach, Charlie’s trust would initially allocate all of the trust assets to the marital trust for the exclusive benefit of the surviving spouse, but it would also create a stand-by family trust that could be used by Charlie’s wife if she wished to do so. The trust would give his wife the right to “disclaim”—i.e.., renounce her right to–some or all of the assets allocated to the marital trust. The disclaimed assets would be put in the family trust for the collective benefit of Charlie’s wife and their children. As a result, Charlie’s wife can decide if and to what extent she wants to share some of the trust assets with her children as co-beneficiaries as opposed to being the sole beneficiary of those assets. For example, Charlie’s wife could disclaim $500,000 of the assets originally allocated to the marital trust, resulting in $500,000 being allocated to the family trust and the remaining $700,000 staying in the marital trust, or she could disclaim $1,000,000 to the family trust, which would cause the marital and family trusts to end up with the same level of assets as they would under the traditional trust tax funding approach.
The benefit of the hybrid approach is that the surviving spouse gets to control if and to what extent trust assets will be allocated to the family trust and potentially shared with the children. The main disadvantage of this approach is that the disclaimer election must be made by Charlie’s wife within 9 months of Charlie’s death; it is not an election that can be made from year to year in varying amounts. As a result, it can put his wife under some level of pressure to make a difficult decision during a time when she may still be grieving.