Marital Trust planning is essential for those couples who are concerned about protecting surviving family members, especially children, and avoiding estate taxation.
Marital Trust planning is the use of trusts to achieve the goals of asset preservation and family protection. The term, “Marital Trust” is used in this article to discuss both marital trusts and non-marital trusts
What is a Marital Trust? There are essentially three types of marital trusts. QTIP (Qualified Terminal Interest Property) Trusts, Estate Trusts and General Power of Appointment Trusts. Each has a specific targeted goal, but the reason why someone would consider a Marital Trust is to provide for their surviving spouse and children.
A QTIP Trust, in most cases, is funded upon the death of one spouse and directs payments of interest income, on at least an annual basis, to the surviving spouse. The remainder in the trust then passes upon the death of the surviving spouse to the children of the original Grantor. The benefit of this trust is that it allows someone with children from a previous marriage to ensure that those children are provided for, while also providing for a surviving spouse. An Estate Trust essentially does the same thing, but requires the remainder to be passed through the surviving spouse’s estate, giving the surviving spouse greater discretion in the allocation of the original asset. A General Power of Appointment Trust is appropriate if there are no children and gives the surviving spouse access to the full amount in the trust during their lifetime.
The most important element of a Marital Trust to remember is that it does not shield assets from estate taxation. They simply postpone the taxation event until the death of the surviving spouse, as there is a unlimited marital exemption upon the death of the first spouse. Assets in a marital trust pass subject to any applicable estate tax guidelines. This is particularly important for QTIP Trusts as they may contain assets earmarked for the children of the Grantor, but are potentially diminished by estate taxation. To shield assets from estate taxation, you must have a Non-Martial Trust.
What is a Non-Marital Trust? Non-Marital Trusts are often referred to as “Credit Shelter Trusts” or “Bypass Trusts.” These trusts allow the Grantor to provide income to their surviving spouse, while ultimately passing assets to the Grantor’s children
Bypass Trusts are irrevocable trusts that can be created during the lifetime of the Grantor or in the Grantor’s Last Will and Testament. If they are created in a Grantor’s Will, they become irrevocable upon the death of the grantor. The trust is funded with an amount equal to the annual exclusion applicable in the year of the Grantor’s death. In 2017, the annual exclusion amount is $5.49 million dollars. A surviving spouse will have access to interest income from the trust and also the trust principal, but only for the surviving spouse’s health, education, maintenance or support. Upon the death of the surviving spouse, the trust remainder passes to the original Grantor’s children tax free.
One important note with Bypass Trusts is that the IRS has a three year look back period for tax free transfers. That means that if the surviving spouse dies within three years of the original Grantor’s death, the assets will be subject to estate taxation. Also, if a family residence is transferred into a Bypass Trust, it will receive the stepped-up value as of the date of the Grantor’s death. However, if the value of the residence continues to increase, any gain attributed from the date of the Grantor’s death to the distribution to beneficiaries will be subject to capital gains tax. A Bypass Trust cannot claim the $250,000.00 personal capital gains exemption.
Surviving spouses are often named as trustees, which makes compliance with tax requirement critical in both the drafting of Bypass Trusts and in their execution after the original Grantor’s death. That’s why it is crucial to consult with an experienced estate planning attorney when considering Marital and Non-Marital Trusts. Remember that a strong basic estate plan is also a must for any family.