We all want to protect our family from financial hardship after our death. Most married individuals believe they can best protect their family by leaving everything they own outright to their spouse. If you share this belief, your good intentions could cost your family hundreds of thousands, if not millions, of dollars.
For example, assume you and your spouse have a combined $8,000,000 estate in 2015. If you die sometime in 2015, and leave everything to your spouse, your spouse will have an $8,000,000 estate at his or her death. Assuming your spouse also dies in 2015, your spouse can shelter $5,430,000 of his or her $8,000,000 estate from estate taxes with his or her estate tax exemption amount.1 If proper planning is not done, there could be an estate tax of approximately $1,028,000 imposed at his or her death assuming he or she died later the same year. With proper planning, both you and your spouse can use your estate tax exemption amounts and transfer both estates to your heirs free of estate taxes.
For individuals who have not utilized their exemption amount, the key is to establish a will or trust that will divide the assets into two subtrusts upon the first spouse's death so that each of you fully utilize your unused estate tax exemption amount. This type of arrangement is commonly referred to as an A/B Trust.
The typical A/B Trust works as follows. One trust (commonly referred to as a B-Trust) will contain as much of the first spouse to die's assets that can pass free of estate taxes ($5,430,000 in 2015). The balance of his or her assets and the survivor's assets will be held in a survivor's trust. The survivor will have unlimited access to the assets held by the survivor's trust and can use the B-Trust for costs related to health, education, support and maintenance. Additionally, the survivor can be given unlimited access to all income from the assets held in the B-Trust. Upon the survivor's death, the B-Trust will pass to the next generation free of estate taxes. The survivor's estate tax exemption amount will be applied to the assets held in the survivor's trust so that all or a portion of the survivor's trust will also pass to the next generation.
Another alternative for married individuals is to take advantage of the portability of the deceased spouse's unused estate tax exemption. Starting in 2011, a decedent's unused estate tax exemption could be transferred to his or her spouse at death, via an election on an estate tax return. This allows married couples who did not establish a will or trust to divide assets at death to still retain full usage of each spouses estate tax exemption. Please note that for portability purposes, the estate tax exemption amount transferable is not indexed for inflation and remains at the exception amount in the year of the first spouse's death and is not indexed for inflation after that date. Depending on the year of the death, it may still be advisable to utilize the benefits of the A/B Trust. Please consult with your tax or legal professional for more details.
With basic planning, you can provide your family with financial stability and maximize the estate tax savings available to you.