When to Amend Revocable Trusts
The fact most of us don’t like to think too hard or often about our own mortality generally puts estate planning low on our priority lists. However, given that we spend a lifetime saving and accumulating assets, it is important to lay out a well-conceived plan for how this wealth will be transferred to others after we are gone. When to Amend Revocable Trusts
Because life and laws inevitably change over time, it is also important to periodically review all estate planning documents to ensure they will still produce the desired results. If you have not looked at your documents in the past five years, it is probably time to dust them off and perhaps meet with your estate planning attorney to see if any changes are warranted.
If your estate plan includes a revocable living trust several provisions should be reviewed for potential revision. First, you will want to see who was named as successor trustee to ensure the successor will still be willing and able to serve in that role when called upon. Provisions governing how assets in the trust are to be distributed after your death should also be reviewed carefully to ensure the beneficiaries you have named, and amounts they are to receive from the trust are still consistent with your wishes.
If a beneficiary’s financial or family situation has changed, it may be appropriate to amend the trust to avoid unintended consequences. For example, if a child is going through a divorce, an outright distribution of funds from the trust could end up in the hands of his or her ex-spouse, rather than being preserved for her, or her children’s benefit. Without appropriate trust language, distributions can end up exactly where you do not want them to go. Trusts can be drafted to protect the property against the claims of ex-spouses and other creditors.
Providing for a surviving spouse is also usually a principal estate planning goal for couples, as is ensuring property is transferred without excessive loss due to federal and state estate taxes. These objectives have generally been accomplished by adding a “credit shelter” or “bypass” provision to revocable trust documents. Under the federal estate and gift tax, spouses are allowed to pass an unlimited amount of property to each other without incurring gift or estate tax. Each spouse is also given a specific exemption amount to shelter property passed to others at their death.
Consequently, when the first spouse dies, estate tax can be avoided by leaving all property to the surviving spouse. At the survivor’s death, estate tax will be due to the extent that the couple’s remaining assets exceed the federal estate tax exemption.
The problem with leaving all property outright to a surviving spouse is that the first spouse is unable to take advantage of his or her estate tax exemption. A better outcome can be achieved by including a bypass provision in the trust that transfers an amount equal to the federal estate tax exemption amount to a separate trust, with the remainder going directly to the survivor. The bypass trust can provide income to the survivor, and can make additional distributions as necessary for the survivor’s, health, support, education or maintenance, but cannot give the survivor unlimited access to the funds. This way, the bypass trust’s assets will not be included in the surviving spouse’s estate and subject to the estate tax. Taxes are minimized via the bypass trust because both spouse’s estate tax exemptions are fully utilized.
Bypass trusts were an effective planning tool when the federal estate tax exemption was limited to $1 million. In 2012, Congress amended the tax rules to allow for a higher exemption amount that is now indexed for inflation, and to provide for portability of the exemption between spouses. In 2016, the estate tax exemption amount is $5.45 million. Consequently, bypass trusts may no longer be needed to avoid federal estate tax. Still, there may be good reasons to retain the bypass trust language including protecting the trust’s assets against creditor claims, preserving assets for minor children, or having the ability to make larger gifts to children without gift tax consequences. If you live in, or move to, a state with its own estate tax, a bypass provision may still be appropriate so that this tax hit can be minimized.
David T. Mayes is a Certified Financial Planner professional and IRS Enrolled Agent at Mackensen & Company, Inc., a fee-only advisory firm in Hampton. He can be reached by visiting www.mackensen.com.