Estate planning is vital for people who want to make sure their assets are managed and distributed based on their wishes. Trusts play a very important part in estate planning, but there are many types of trusts. Here we’ll talk about a disclaimer trust.
What is a Disclaimer Trust?
A disclaimer trust is a type of trust that can be used by a married couple. Basically, the married couple’s will or revocable trust mentions that the surviving spouse has the option to use a disclaimer trust, which is only funded if the surviving spouse chooses to disclaim an asset they inherited from their spouse. This kind of trust offers a lot of flexibility and can help minimize estate taxes for married couples.
When the first spouse dies, their assets are often left to the surviving spouse. The surviving spouse can choose to accept the assets or to disclaim (refuse) assets that are part of that inheritance. Those disclaimed assets get passed to a marital disclaimer trust, which can benefit the surviving spouse during their lifetime, without being part of the surviving spouse’s estate when they die.
A disclaimer trust allows the married couple the flexibility to wait and see what the surviving spouse wants to do. The surviving spouse can assess the situation at that time and decide if it makes sense to use the disclaimer trust.
What Are Estate Taxes?
Before we can further explain a disclaimer trust, it’s important to understand estate tax. The estate tax is applied to certain estates after a person has died before those assets are dispersed amongst their beneficiaries. It applies to the gross estate value (the total dollar value of a person’s assets at the time of death), plus adjusted taxable gifts, that exceed a certain threshold.
As of October 4, 2023, the Massachusetts estate tax exemption is $2 million for people dying on or after January 1, 2023. That means that typically when a person dies owning $2 million or less in assets, they pay no estate tax. However, if their estate is valued over $2 million, the estate is taxed on the amount over the $2 million.
There’s also a Federal estate tax. In 2024, the Federal estate tax exemption is imposed only on estates valued over $13.61 million, while married couples can have over $27.22 million.
Most people won’t be affected by the Federal estate tax, so let’s focus on the Massachusetts estate tax. To establish whether your estate will owe a Massachusetts estate tax, the government will look at the fair market value of everything you own at time of your death, including cash, securities, real estate, business interests, trusts, annuities, life insurance proceeds, 401(k)s, and other assets.
Frequently when a spouse dies, they leave everything to the surviving spouse. This wastes the $2 million exemption of the first spouse. That transfer won’t be taxed since bequests to a surviving spouse aren’t subject to estate tax due to marital deduction rules.
For example, Mike and his wife Sharon are married and have combined assets worth $3 million net—each one owning $1.5 million in assets. They have no taxable gifts. When Mike dies, he leaves his assets directly to his wife Sharon. But now Sharon owns all the couple’s assets and only has her own $2 million exemption to work with. So, when she dies with $3 million in assets, estate tax will be applied to the amount of her estate that is over $2 million. That’s where a disclaimer trust comes in. Assets in the disclaimer trust bypass Sharon’s estate and won’t be subject to Massachusetts estate taxes when Sharon dies.
Advantages of a Disclaimer Trust
- It reduces estate tax liability to better provide for the trust beneficiaries.
- Assets in a disclaimer trust are generally protected from creditors. Disclaimer trusts are typically irrevocable, meaning once it’s created and assets are placed in it, the trust can’t be revoked or changed. The assets in it are owned by the trust not the surviving spouse. Therefore ,the trust’s assets are shielded from things like lawsuits and creditor claims.
- The surviving spouse can benefit from the assets in the disclaimer trust.
- It gives the surviving spouse the flexibility to make a decision after the death of the first spouse based on their current situation. For example, let’s say the estate plan was put together ten years ago. Back then their estate planning couldn’t take into consideration future laws, changes in the economy, or unexpected financial needs of the surviving spouse. The disclaimer trust allows the surviving spouse to make a decision based on an assessment of the current situation.
Disadvantages of a Disclaimer Trust
- The surviving spouse has to act quickly to fund a disclaimer trust, generally within nine months of death, which can be difficult to do during the grieving process. If the surviving spouse doesn’t meet the deadline, this trust will fail to meet your tax planning objectives.
- The surviving spouse needs to be competent to fund disclaimer trust and have the capacity to know how to disclaim assets appropriately.
- Setting up a disclaimer trust can be complex. Also, you need to determine what assets should be disclaimed, which means you should consider:
- The value of the estate
- The estate tax exemption amount
- The possibility there may be significant changes in the value of the estate
- Any upcoming changes in tax law
- Both spouses must trust each other since the surviving spouse will have full control over both spouses’ assets. The surviving spouse could change the estate plan, adjusting what assets go to what beneficiaries.
How Does a Disclaimer Trust Work?
After the first spouse dies, the surviving spouse can decide if they want to create a disclaimer trust. Here are the steps for creating a disclaimer trust:
- Select an estate planning attorney to work with.
- Figure out what assets should pass to the disclaimer trust.
- Designate the trustee (usually the surviving spouse), any successor trustees, and the beneficiaries.
- Determine the terms of the trust.
- Transfer disclaimed assets to the trust.
Marital Disclaimer Trust Requirements
A marital disclaimer trust does have these requirements:
- The surviving spouse can’t accept the assets.
- The surviving spouse can’t provide any direction on the distribution of the assets either before or after disclaiming them.
- The surviving spouse must typically choose to disclaim assets within nine months of the date of death of their spouse.
- The deceased spouse’s will or trust must include wording about the marital disclaimer trust for the surviving spouse to be able to disclaim assets during their own lifetime
A marital disclaimer trust can provide a lot of flexibility, but the use of a marital disclaimer trust comes with responsibility. Whether you choose to use a disclaimer trust as an option in your estate planning documents is an important decision. Is it the best option for you? Our estate planning attorney can meet with you to thoroughly discuss the estate planning tools and techniques that would work best for you. Call us today at (617) 765-9307.
