Does your trust need a tune-up?
BY KELLY GREENE, The Wall Street Journal — 04/16/11
Families can now shelter a far greater amount of their assets from
estate and gift taxes. But they may need to revisit their estate
The tax law that Congress enacted in December upped the amount
individuals can leave their heirs, or give away during their lifetime,
to $5 million from $1 million without incurring estate or gift taxes,
which top out at 35%. Congress also passed a "portability" measure
allowing spouses to combine their exemptions up to $10 million.
But both provisions are set to lapse after 2012. And in a climate of
budget cuts and renewed talk of tax increases on the wealthy, no one
knows if the higher exemption amounts will stick. Experts expect
portability to be extended — though states that levy their own estate
taxes haven't yet adopted it, according to CCH Wolters Kluwer.
All this means that families need to be prepared for any contingency.
The way many estate plans are currently worded could cause them to
backfire, either by triggering unnecessary state estate taxes or even
accidentally disinheriting a surviving spouse.
'You change it'
"We have at least 20 to 30 married couples every month who come in
with the question, 'With the new estate-tax law, what do we do with
our trust? Do we change it or get rid of it?'" says Philip Kavesh, an
estate-planning attorney in Torrance, Calif. "The answer is, you
One of the most commonly used estate-planning tools is the so-called
bypass trust — also called a "credit shelter" or "AB" trust — which
can double the amount a couple can shield from estate taxes.
Here is how the strategy typically works: When one spouse dies, the
maximum amount exempt from estate taxes goes into a trust, with both
the surviving spouse and the couple's children named as beneficiaries.
Typically, the surviving spouse uses the interest; after the second
spouse's death, the remaining assets pass, tax free, to the couple's
heirs, preserving both individual exemptions.
Herb and Kathe Cook, a retired magazine publisher and Fannie Mae
executive, respectively, set up bypass trusts five years ago after
they retired, fine-tuning them to Washington state law after moving to
the Olympic Peninsula from Ohio.
Enough wiggle room
They re-evaluated them after the law change and decided to keep them,
since the trust documents already provided enough wiggle room: The
trust language lets the amount sheltered increase along with the
government estate-tax exemption limit, and it also would let the
survivor tap the principal if needed.
Many older bypass-trust plans lack such a provision. Building in such
flexibility is key to a successful trust at a time when the estate-tax
law is in such flux, says the Cooks' adviser, John Schuman, a
certified financial planner, CPA and attorney at Budros Ruhlin & Roe
in Columbus, Ohio.
Waiting for congress
Since Mr. Cook is 69 years old and Ms. Cook is 62, he estimates that
they both could live at least a few more decades, potentially leaving
their children with a $10 million to $15 million inheritance.
"We're right in that cusp area where we aren't quite sure what is the
appropriate thing to do, so we're waiting to see what Congress does
after 2012," he says.
Many families also will want to consider capping the amounts that
automatically flow into a bypass trust after the first spouse's death,
says Jonathan Graber, a partner at Katten Muchin Rosenman in Chicago.
Volatile markets and the higher estate-tax exemption could mean a
bypass trust winds up with the bulk of an estate. In a worst-case
scenario, the surviving spouse would have to ask the children for
money to cover living expenses.
Another reason to consider a cap: Sixteen states and Washington, D.C.,
levy their own estate tax, according to CCH — and in many of those,
the exemption is substantially lower than the federal government's.
That could result in a hefty state estate-tax bill.
New York, for example, allows only $1 million to go to heirs free of
estate tax. "If Mom dies with a $5 million estate that goes into a
credit-shelter trust for Dad, you can generate more than $444,000 in
New York estate tax," says Blanche Lark Christerson, a managing
director at Deutsche Bank's private wealth-management unit.
Creating trust 'buckets'
Illinois's exemption is $2 million, so Mr. Graber often sets up three
trust "buckets" for his clients: For a couple with $10 million, one
trust bucket (after the first spouse dies) would get $2 million free
of state and federal estate tax; the second would get $3 million
subject to state estate tax but not the federal levy; and a third
would get the remaining $5 million for the surviving spouse's living
Illinois and a handful of other states let couples put the amount
subject only to state estate tax — the second bucket — into what is
called a "qualified terminable interest property" trust, which
provides a surviving spouse with income, and sometimes principal,
while delaying estate tax until after the survivor dies.
"You're postponing the state estate tax, and you might use the money
anyway," Mr. Graber says.
One other caveat: To take advantage of portability, you must file an
estate-tax return upon the first spouse's death. "Preparing an estate-
tax return can range anywhere from $2,500 to $10,000," Mr. Kavesh
says, "so the cost of setting up [bypass] trusts might actually have
Copyright © 2011 Dow Jones & Company, Inc. All Rights Reserved.