Flexibility is Key – Disclaimer Trust Planning

In planning for your estate, as in planning for life, the thing to remember is that change is inevitable. The change may be to your family circumstances or to the gift and estate tax regime, but, one thing is for certain, change will come! While we may not be able to see the future, we can implement planning with an eye on flexibility in case circumstances look different when your planning needs to be implemented from when your estate plan was created. Disclaimer trust planning is a perfect example of building in flexibility for married couples, especially as it relates to achieving tax savings on the death of the surviving spouse. Let’s look at how it works.

What Is A Disclaimer?

A disclaimer is a refusal to accept property or assets left to you upon a person’s death. To disclaim your interest in an inheritance is to legally decline to receive that inheritance. In order to understand how disclaimer trust planning works, it is important to first understand qualified disclaimers. To be “qualified”, a disclaimer must be:

  • Irrevocable;
  • In writing and delivered pursuant to the controlling tax Code and local relevant statute(s);
  • Made within nine (9) months from the date of the gift (in the case of disclaimer planning on the death of the first deceased spouse, the “gift” is deemed to have been made on the date of death);
  • The disclaiming person cannot have received any interest or benefits from the property being disclaimed; and
  • The disclaiming person cannot direct how the assets being disclaimed are to be distributed (however, for a surviving spouse disclaiming assets intended for his or her benefit, there is an exception to this rule, discussed further below).

Disclaimers can be complete or partial (meaning you can disclaim all of the assets from which you stand to benefit, or just some). When a qualified disclaimer occurs, the taxing authorities permit the property to skip to the next person in line (the contingent beneficiary) without creating a taxable gift on the part of the disclaimant.  

When a surviving spouse disclaims his or her interest in the deceased spouse’s estate, that interest can pass instead to a trust for the benefit of the surviving spouse during his or her lifetime (a “Disclaimer Trust”).

What are the Benefits of Including Disclaimer Provisions in a Will?

Assets left to a surviving spouse, upon the death of the first spouse qualify for the “marital deduction” for estate tax purposes. No estate tax is due for assets that pass to the surviving spouse upon the first spouse’s death. However, upon the death of the second spouse all the assets in the second spouse’s estate above the then existing estate tax exemption would be subject to the estate tax (if you have a taxable estate). On the other hand, assets in a properly structured Disclaimer Trust for the benefit of the surviving spouse are excluded from the surviving spouse’s taxable estate. This makes a Disclaimer Trust a powerful tool for post-mortem tax planning (a very exciting way to say that the surviving spouse will have another bite at the tax planning apple when they know whether there is a potential estate tax issue on the death of the first spouse). A Disclaimer Trust can also provide asset protection for the surviving spouse during his or her lifetime, depending on how the trust is structured and administered.  

Disclaimer Trusts are “flexible” because the decision to use the Disclaimer Trust is optional. The surviving spouse is given the opportunity to take advantage of any tax benefits that were not available when the Will was drafted. If, however, at the time of the spouse’s death it would be unnecessary or inappropriate to place such assets in trust, the surviving spouse can choose not to make a disclaimer, in which case the assets will simply pass outright to the surviving spouse. 

How are Disclaimers Structured in Estate Planning?

The Disclaimer Trust will contain provisions that direct how distributions can/should be made for the benefit of the surviving spouse, including direction regarding income and principal distributions. The Disclaimer Trust can provide for mandatory distribution of all the trust income to the surviving spouse and for discretionary distributions of principal. Alternatively, the Disclaimer Trust can state that distributions of both income and principal are to be discretionary (meaning, at the discretion of the Trustee). The surviving spouse can be the Trustee or a co-Trustee of the Disclaimer Trust and have access to the trust income and principal during their lifetime for their own health, education, support and maintenance, often referred to as the “HEMS” standard. In addition, an independent Trustee (if one is acting) can be authorized to make distributions for any reason that is in the surviving spouse’s best interest. An independent Trustee is one who has no beneficial interest in the trust.  

Disclaimer provisions add flexibility to your estate planning, which can be very beneficial if circumstances change after the estate plan is implemented. If properly structured, disclaimer planning between married couples can save on estate tax that may otherwise be payable on the death of the surviving spouse.  

We would be happy to further discuss disclaimer planning and its potential benefits with you and to help you consider whether disclaimer planning makes sense for you and your family.