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Simple Will vs Disclaimer Trust Will vs A-B Trust Pt. 1

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The following is a letter I sent to a client describing the differences between a Simple Will, Disclaimer Trust Will and A-B Trust.  I hope you find this information enjoyable and educational.

The following information compares and contracts the basic tools we have regarding your estate plan.  We will look at the simple will, a will with disclaimer trust and contingent trust provisions and an A-B QTIP trust plan.  These three plans correspond with the ?Simple Will Plan,? ?Family Security Plan,? and ?Trust and Tax Savings Plan.?  The general pros and cons of each plan will be assessed and a recommendation will be made as to which financial and life situations are most appropriate for each type of plan.  I will also be making recommendations for your particular situation and attempting to provide you with the information you need to make the most informed choice possible.  To better understand these plans better you may find it helpful to reference the illustrations included at the end of this letter.

            Some important numbers and definitions to remember:

• Net Worth:  When I refer to a net worth included in that number is all of the assets you own, life insurance, 401k, IRA?s, investment vehicles and the like.  Many people are under the mistaken impression that life insurance does not count as an asset of the estate when the estate tax calculations are made. 
• Applicable Exemption Amount:  The 2008 Federal Estate Tax Threshold is $2 million, which means that you can pass on a total of $2 million before your estate will be subject to an estate tax.  Married couples can pass an unlimited amount of assets to each other and due to the unlimited marital deduction no tax will be due when spouses pass assets on to each other.
• Unlimited Marital Deduction:  Spouses can pass unlimited amounts of assets to each other due to the unlimited marital deduction.  Upon the death of a spouse, for every dollar that is transferred to the surviving spouse they receive a dollar of deduction.  No estate tax will be owed for any amount of assets passed between spouses.
• Wasting the applicable exemption amount:  When the first spouse dies and all assets are passed to the surviving spouse outright the applicable exemption amount is wasted.  The surviving spouse?s estate will be taxed if it passes on a total amount of assets over the applicable exemption amount.  If the first spouse to die were to pass assets to a trust, which would be used to support the surviving spouse, and then pass the remainder to the surviving spouse we can double the assets that are passed on to the children tax free. 
  • For example:  John and Jane are married and have an estate worth $5 million.  If John passes away in 2008 and passes on his half of those assets to Jane her estate will be worth $5 million and not tax will be due because of the unlimited marital deduction.  But when Jane passes away she will be $3 million over the applicable exclusion amount and will be on the hook for a substantial tax bill of about $900,000. 
  • If when John had passed away in 2008 he had a tax plan in place he could have passed on the applicable exclusion amount (in 2008 $2 million) in to a trust that would be used  support his wife and passed the remaining on to his wife.  His wife would have received $500,000 (the remainder of John?s assets) and the trust would have received $2 million.  The trust language states that it is to be used for the support of Jane for her life and then pass to their children.  No tax would be due on this transfer.  The important part comes when Jane passes away.  She has $2.5 million ($2MM of her own and $500k from John) to pass on to her children.  If she passes away in 2008 she will have $2,500,000 to pass on.  Since she is over the applicable exclusion amount by $500,000 and will be taxed on that part of the transfer.  But remember, we have $2 million in trust and that will pass tax free to the children. 
  • In the first part of the example no tax was paid on the first death but we were only able use Jane?s applicable exclusion amount to transfer $2 million tax free.  With the trust plan we used both John and Jane?s applicable exclusion amount and transferred $4 million to the children

 

*All estate plans include a Health Care Directive and Power of Attorney

 

Simple Will Plan

 

            The first estate planning option to be analyzed is the simple will plan.  The will in the simple will plan allows the client to choose their personal representative, guardians for their children and lay out to whom they want their assets to pass.  If the parents were to pass away before the children reach age 18 the assets will be held in a court ordered trust and distributed to them outright when the reach 18.  If the parents were to pass away after the children reach age 18 those children will receive the assets to which they are entitled outright.

 

Pros:

• The upfront cost is low
• Your documents are simple and more easily understood
• Your children will receive assets outright
• You can name guardians for your children

Cons:

• If your children are not old enough or capable of handling substantial sums of money they may not spend or invest the assets wisely
• No tax savings provisions
• No use of each spouses applicable exclusion amount

 

Recommended for:

• Clients with a combined net worth below $500,000 and/or
• Clients with no children or adult children that can financially handle their inheritance

 

Family Security Plan:

 

            The Family Security Plan includes everything in the simple will plan with the addition of disclaimer trusts for the parents and contingent trusts for the children.  The disclaimer trust is a trust we describe and set rules for in the will, but no actual trust is created at the time of execution of the document.  The disclaimer trust is a tax savings vehicle that takes advantage of the unlimited marital deduction and the applicable exclusion amount.  If, upon the death of the first spouse, it appears that the surviving spouse will receive more assets than the applicable exclusion amount the surviving spouse can elect to ?disclaim? those assets and have them pass to the disclaimer trust.  The disclaimer trust is used to support the surviving spouse for life and then to pass any remaining assets on to the children.  Just like the example above we won?t have wasted the applicable exclusion amount of the first spouse to pass away.

            The contingent trusts for the children are trusts that are described in the will but again are not created at the time of the execution of the will.  It sits there in the will and waits to see if it?s needed.  If the parents pass away before their children reach a certain age (an age that the parents choose) it will be created and funded with any assets that were to pass to the children.  This trust would be used to support the children just as the parents would have supported the children.  The parents determine in their will when the children will be able to receive all or a portion of the trust property.  If the children are older than the latest distribution date of the trust when the parents pass away the trust is not created and the children receive their inheritance outright.

 

Pros:

• Not expensive to set up
• Parents have tax savings clauses available to them
• Life Insurance proceeds can be disclaimed in to the disclaimer trust
• Trusts do not have to be set up now and no change in the ownership of major assets is likely needed
• The children?s inheritance is protected from the possibility that they are too young or financially immature to handle their inheritance
• Parents choose who will be the guardians of their children
• Parents pick their personal representative

 

Cons:

• Costs slightly more than simple will plan

 

Recommended for:

• Clients with a combined net worth between $500,000 and $5 million
• Clients who would like to have the opportunity to save on estate taxes
• Clients with young children or those they do not believe are old enough to properly manage the assets they may receive

 

Full post as published by Minnesota Estate Planning Blog on August 03, 2008 (boomark / email).