Separate trusts? Be sure you understand what you need

Dear Jonathan: Several years ago my wife and I completed our estate planning. At that time our estate was worth around $2 million and the exemption from federal estate taxes was only $1 million. Consequently, our attorney recommended that we prepare separate trusts which would allow each of us to take advantage of the exemption amount so there would be no federal estate taxes due at the death of the second one of us to die. I don’t really remember or necessarily understand the strategy other than the fact that we had to create two separate trusts in order to avoid federal estate taxes at the second death.

My wife and I are now updating our estate planning and it is my understanding that the exemption from federal estate taxes is now in excess of $5 million. It is my further understanding that because our estate is worth well below that amount, it is no longer necessary to utilize the separate trusts strategy in order for us to avoid incurring federal estate taxes at the second death.

As a result, we are considering preparing a joint trust to hold our assets rather than maintain the two separate trusts. Does this make sense? I should also mention that we both have children from previous marriages and we want to provide something for our respective children at each of our deaths.

Jonathan says: Your understanding is correct that the increase in the federal estate tax exemption amount, which is currently $5.34 million per person, makes it unnecessary for a husband and wife to engage in the two-trust strategy to minimize or avoid federal estate taxes if the total value of the estate is less than the exemption amount. However, if the value of the estate is close to the exemption amount and there is a likelihood that the estate will appreciate in value, having two trusts may still make sense; each case is different. In your case, however, it appears from your question that your estate is worth well below the exemption amount so having two trusts specifically for tax planning purposes is no longer necessary.

Although there may no longer be a reason to have separate trusts for the purpose of avoiding federal estate tax at the second death, you may still want to maintain those separate trusts if you want to make sure that your respective children receive what each of you want them to receive at each of your deaths. This is because a joint trust continues to be revocable so long as one of you is still living and has legal capacity. As a result, whoever survives between the two of you would have the ability to amend or even revoke the trust and could eliminate the decedent spouse’s children as beneficiaries under the trust.

If you decide to go forward with a joint trust, both of you will need to understand that the surviving spouse has the ability to change the terms of the trust and that the children of the first spouse to die may not end up receiving what that spouse intended them to receive. If both of you are okay with that and are willing to take the risk, then go ahead and prepare the joint trust.

If, on the other hand, each of you want to make sure that your children actually receive their share of the estate, I recommend that each of you maintain separate trusts and provide for your respective children through those trusts. Upon your death, for example, your separate trust will become irrevocable and your spouse will be unable to amend or revoke that trust like she would be able to do with a joint trust and as a result, your children would receive the share you have designated for them.

Another option to consider is to go ahead with the joint trust but have each of you provide for your separate children outside of the trust. You could do this by naming them as beneficiaries of a life insurance policy or some other investment. By providing for your respective children outside of the trust, you could use the joint trust for the purpose of controlling the disposition of the balance of your assets.

I recommend that you meet with an estate planning attorney in your area who can further explain the pros and cons of maintaining separate trusts and creating a joint trust, as well as other types of estate planning documents that you should consider drafting or updating. Good luck.

Jonathan J. David is a shareholder in the law firm of Foster, Swift, Collins & Smith, P.C., in Grand Rapids, Mich.

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