Introduction
A disclaimer is a refusal to accept money or other property by someone who would otherwise be your beneficiary according to your will, trust, gift, insurance policy, retirement account, or your state’s intestacy laws. The person who disclaims the property (the “disclaimant”) is treated as if he or she predeceased you and never received the property.
There are several situations where a potential beneficiary might want to forgo property to which he or she is entitled. Often, these situations can be anticipated, and a disclaimer trust can be created to receive disclaimed property, which is then administered and distributed according to the terms of the trust.
Why use a trust?
Without a disclaimer trust, the disclaimed property would pass directly to other individual beneficiaries according to your state’s laws. Planning with simple disclaimers (i.e., where no trust is used) can be appropriate in many situations. In those situations, you can simply specify in your will that any disclaimed property go directly to someone else (e.g., “If my spouse disclaims any bequest, the bequest shall pass in equal shares to my three children”). However, there are some situations where directing the disclaimed property to a specific individual should be avoided.
Providing for a child with special needs
What if one of your adult children was receiving state-funded benefits for special needs? A sudden windfall could disqualify the child for state aid, resulting in at least a temporary interruption in his or her care. To avoid this situation, you could provide that some or all of the disclaimed property would go to a disclaimer trust for the benefit of the child with special needs.
Caution: Drafting this type of trust requires particular legal expertise to ensure that the child with special needs remains entitled to government benefits under your state’s laws.
Marital bypass planning
A disclaimer trust is often used as an alternative to a bypass trust (also known as a credit shelter trust) in order to provide more flexibility. Bypass planning is designed to both minimize federal estate taxes for married individuals, and allow the surviving spouse to benefit from the family’s wealth during his or her continuing life. This can be accomplished by taking full advantage of the applicable exclusion amount, which protects $12,060,000 (in 2022, $11,700,000 in 2021) from estate tax, and the unlimited marital deduction, which allows spouses to transfer property between themselves gift and estate tax free. In 2011 and later years, the unused basic exclusion amount of a deceased spouse is portable and can be used by a surviving spouse.
Tip: Portability of the basic exclusion amount between spouses in 2011 and later years may reduce the need for marital bypass planning.
Caution: The basic exclusion amount is indexed for inflation. However, any portable unused basic exclusion amount transferred to a surviving spouse is not indexed for inflation after the death of the first spouse to die.
Here is a typical scenario where bypass planning is needed:
Example(s): Dave and Ann are married and Dave has an estate of $20 million. Assume an applicable exclusion amount of $12,060,000 (that will be indexed for inflation after the first spouse dies), a 40 percent top tax rate, portability, and that values (other than any unused exclusion) double over time after the first spouse dies. Dave dies first and leaves $20 million to Ann. The transfer to Ann qualifies for the marital deduction and no estate tax is due at Dave’s death. Dave’s estate elects to transfer Dave’s unused exclusion to Ann. At Ann’s death, Ann’s $40 million estate is greater than her $36,180,000 applicable exclusion amount (Ann’s $24,120,000 exclusion amount and Dave’s $12,060,000 unused exclusion), and federal estate tax of $1,528,000 is due. The children receive only $38,472,000 after federal estate tax is paid.
To avoid this situation, the couple in the above example could have used a bypass trust. With a bypass trust, property is transferred from the estate of the first spouse to die to the bypass trust such that his or her applicable exclusion amount is fully used. The remainder of the assets of the first spouse to die is then transferred directly to the surviving spouse or to a marital trust for the surviving spouse’s benefit. To prevent inclusion of the bypass trust in the estate of the surviving spouse, he or she is given only certain rights and limited control over the assets in the trust. The surviving spouse may receive income from the trust or may be given the right to invade the trust principal for his or her health, education, maintenance, or support. The surviving spouse may also be given a limited power of appointment over the assets in the bypass trust. A limited power of appointment permits the power holder to direct that the assets in the trust ultimately pass to a limited class of beneficiaries that does not include himself or herself, his or her estate, his or her creditors, or the creditors of his or her estate.
Example(s): Dave and Ann are married and Dave has an estate of $20 million. Assume an applicable exclusion amount of $12,060,000 (that will be indexed for inflation after the first spouse dies), a 40 percent top tax rate, portability, and that values (other than any unused exclusion) double over time after the first spouse dies. Dave dies first. Dave leaves $20 million to Ann and provides that anything disclaimed by Ann passes to a disclaimer credit shelter trust. Ann disclaims $10 million. The $10 million transferred to the credit shelter trust is protected by the applicable exclusion amount and the $10 million transferred to Ann qualifies for the marital deduction, and no estate tax is due at Dave’s death. At Ann’s death, Ann’s $20 million estate is fully protected by her $24,120,000 applicable exclusion amount, and no federal estate tax is due. In addition, the $20 million in the credit shelter trust at Ann’s death bypasses Ann’s estate, so no estate tax is due. The children receive the entire $40,000,000 since no federal estate tax has been paid.
A married couple who wishes to set up a bypass trust should first divide up ownership of their assets. After the division, each spouse should own in his or her own name an equal share of the couple’s total assets. If one spouse owns all the assets alone or all their assets are owned jointly, the couple may not be able to fully use the applicable exclusion amount of each spouse. If one spouse owns all the assets alone, and the other spouse dies first, the applicable exclusion amount of the first spouse to die will be wasted as there will be no assets in the estate to which it can be applied. Correspondingly, the estate of the surviving spouse may be overqualified (i.e., have more than the applicable exclusion amount in the estate). Similarly, if both spouses own all assets jointly, when one spouse dies, the other spouse automatically owns all of the assets. When the surviving spouse then dies, his or her estate may be overqualified. If ownership of their assets is split up between the married couple, each individual will have assets to which his or her applicable exclusion amount can be applied.
Tip: Portability of the basic exclusion amount between spouses in 2011 and later years may reduce the need to divide up ownership of assets or for marital bypass planning.
As an alternative to the bypass trust, which forces (1) the couple to divide their assets, and (2) the estate of the first spouse to die to fund the trust with a specific amount, a disclaimer trust (1) lets the couple own property jointly, and (2) gives the surviving spouse the option to fund the trust with an amount that makes sense, or not to fund the trust at all. The surviving spouse can base his or her decision on the circumstances that then exist. A disclaimer trust is structured like a bypass trust; the surviving spouse receives all the income and can dip into the principal to the extent necessary for his or her health and support.
Disadvantages
Surviving spouse may fail to make the disclaimer
The surviving spouse must act quickly to fund a disclaimer trust, generally within nine months of death. If the surviving spouse does not make the disclaimer in a timely fashion, or otherwise fails to make an effective disclaimer (there are several requirements), this post-mortem planning device will fail to meet your planning objectives.
Heirs of the first spouse to die are not guaranteed a share of deceased spouse’s estate
With a disclaimer trust, the decision to fund the trust lies with the surviving spouse. If the surviving spouse does not disclaim or fund the trust, the heirs of the deceased spouse may not receive any of the decedent’s estate. Therefore, this type of trust may not be appropriate if a spouse wants to ensure a legacy to his or her heirs. This may be the case, for instance, when there is a second marriage and there are children from a previous marriage.
This article was prepared by Broadridge.
LPL Tracking #1-05113129
