Blindly Leaving Everything to Your Spouse Because of “Portability”

As promised in my earlier articles, over the next few months I will continue to share a portion of my Special Report, The 10 Most Common Estate Planning Mistakes and How To Avoid Them in my monthly column.

  In this segment I will cover the third most common mistake people repeatedly make.  To order the complete report click here.

Since the Tax Act of 1981 and the introduction of the 100% marital deduction, the majority of America’s affluent have elected to pass their portion of the estate to the surviving spouse.

For decades the premiere tax efficient strategy of choice was to transfer, at the passing of the first spouse, up to the individual federal estate tax exclusion of the day, be it $1,000,000 or $3,000,000, into a Credit Shelter or By-Pass Trust (B Trust).

The main reason for this move was to ensure that all future growth of the B Trust assets would be excluded from future estate taxes.  An estate freeze strategy.

The surviving spouse would receive the remaining assets and place them in their “A” or Spousal Trust to provide subsistence.

The surviving spouse was also entitled to receive 5% of the value of the B Trust per year and whatever the trustee determined they needed for health, education and maintenance, (see Figure).

While most employed the A/B Credit Shelter strategy to take full advantage of the federal and state estate tax exclusions, they usually were unaware of the many other estate planning benefits this simple move provided.

With the passage of the American Taxpayer Relief Act of 2012 and the introduction of the “portability” clause, the apparent need to set up the A/B Trust in advance has been questioned.

Simply stated “portability” allows a couple to use both federal estate tax exclusions regardless of when the survivor passes away, next year or 20 years from now.

Many have fallen prey to this deceptive strategy and therefore have either abandoned their prior plans or ignored planning altogether.  This is a dangerous trap.

While it may be true that “portability” allows for the use of both federal estate tax exclusions, there are so many other reasons why it is prudent to establish an A/B Credit Shelter Trust now while you are alive.

Furthermore, of the states that impose an inheritance tax, currently only Hawaii recognizes “portability.”  To determine if your state still levies an inheritance tax, and “portability” is of no consequence visit our website:  www.epmez.com.

Solution:

A few uninformed planners and politicians suggest that because of this new “portability” provision and given the fact that the federal estate tax exclusion is a whopping $5.49 million, a Credit Shelter Trust isn’t needed.

I asked a national estate and asset protection law firm, to list the reasons why following the “portability” trap is such a bad idea.  Here are their answers:

  • Portability merely makes the exclusion portable between spouses, nothing else. The biggest effect is that a couple can have a single joint trust and hold their assets in common, provided it has credit shelter provisions, even in separate property states.
  • If a Credit Shelter trust is established, all assets transferred to the B trust at the passing of the first spouse will not be subject to future estate taxes.  If $2 million is transferred it is always valued at $2 million for estate taxes even if it grows to $20 million. If you have a large estate and only use “portability” at the passing of the second to die, you lose the opportunity of “freezing” the first exclusion from future estate taxes.
  • You still have to make an election even with “portability.”
  • If your estate is in excess of the federal estate tax exclusion, you still have to file The IRS Estate Tax Form 706.
  • You still need to have a means of administering the exclusion even with “portability.”
  • A Revocable Family Dynasty Trust (RFDT) provides the means of administering your assets while living and when transferred at death. If your estate is large enough to be concerned about the full use of the new “portability” rules and you do not have a properly executed trust, you are setting up your heirs to face a world of confusion and contention.
  • A Credit Shelter Trust allows the surviving spouse to retain an income interest and control over the assets. Without the CST, the assets would simply pass to the deceased spouse’s heirs with little or no immediate or future control.
  • A Credit Shelter trust can allocate and administer the deceased spouse’s Generation Skip Transfer exclusion which is currently the same as the $5.49 federal estate tax exclusion.
  • A Credit Shelter trust provides some asset protection for the surviving spouse if properly crafted, especially from ex-spouses of your children and grandchildren.
  • A Credit Shelter trust may provide for Medicaid planning for the surviving spouse, as long as the transfer is completed 5 years prior to their death.
  • A Credit Shelter trust can be part of “dynasty” planning which plans for protecting wealth over multiple generations, not just dealing with death and related taxes.

Ten convincing reasons why you should ignore the politicians’ attempt to deceive Americans into believing that we don’t need to plan our estates.  As is evident, even modest estates should include an A/B Credit Shelter Trust as part of their estate planning.

Furthermore, and most important, estate planning is much more than estate taxes.  It is planning the logical distribution of your assets, no matter how much or how little that may be.

Another concern I often hear is that sudden wealth through inheritance can spoil children and grandchildren.

While we’ve all heard such horror stories, mostly in novels like John Grisham’s book, The Testament or celebrity dramatics, they can be eliminated altogether with proper planning.  Most problems, like those facing Prince’s are a result of zero planning.

Competent estate planning attorneys recommend the establishment of incentive clauses in a trust.

For example, it can be stipulated that a beneficiary’s inheritance be received after certain life goals are achieved; such as, an annual income level, a college degree, marriage, free from addictions, etc.

Age factors should also be considered, but not be the only provision.  Of course, such clauses may not be needed if your heirs are older or are capable of handling an inheritance.

I recommend a simple Revocable Living Trust (RLT) for estates under $500,000 and a Revocable Family Dynasty Trust (RFDT) for larger estates.  Many fret over the up-front costs of such vehicles, and so they put it off and allow probate expenses to be assessed at death, usually 3% to 10% of the gross estate value.

Financial tightness today will cost thousands tomorrow.

A properly attorney crafted RLT costs around $3,000 and a RFDT, $4,000.

An estate comprising of a home valued at $300,000 with a $150,000 mortgage, a $200,000 investment account and real estate of $200,000, would have an estimated probate expense of $35,000.  ($300,000 + $200,000 + $200,000 = $700,000 total gross estate x .05% in probate fees = $35,000).

A properly designed RFDT is only $4,000, a huge savings in the long run!

Next month, Mistake 4:  Paying too much income and capital gains tax.  To immediately discover all 10 mistakes you can order my comprehensive report by clicking here.

Until next time,

David Phillips

David T. Phillips is CEO of Phillips Financial Services and founder and CEO of Estate Planning Specialists. Mr. Phillips is a nationally recognized consumer advocate for insurance, annuities and estate planning with over 42 years of experience. He is the author of bestselling books and has been a featured on national television including: CNN, Fox News, CNBC, Money Talks, and Bloomberg.