Trust-Busting: Un-planning Your Estate

Teddy Roosevelt used to be called the Trust Buster because he forced the great railroad combination in the Northwest to break apart. He was the avowed foe of all sorts of trusts and monopolies.

Now the term ”Trust Buster” may have a new meaning. Lots of folks find themselves with trusts set up for estate tax savings that they no longer need. What changed? The rules on federal estate taxes.

In 1997 the federal estate tax exemption was only $600,000. It has moved steadily upward, hitting $1 million in 2002, $2 million in 2006, $3.5 million in 2009 and $5 million in 2011. Thanks to the “fiscal cliff”, the exemption was scheduled to drop on January 1, 2013, from $5.12 million to $1 million. But the American Taxpayer Relief Act of 2012 (enacted on January 2, 2013) set the exemption at $5.25 million, or $10.5 million for couples with proper planning.

Many people who made wills and trusts in the 1990’s and early 2000’s had plans that were appropriate when the exemption was very low. Many of them involved trusts. Under the current law, these plans are often inappropriate and contain trusts that are not needed. In fact, many married couples have plans that they assume gives everything to the surviving spouse when, in fact, the plans contain formulas referring to the federal exemption that result in the estate of the first spouse to die going entirely to a trust!

A common plan for a married couple to have is an A B trust plan or bypass trust. Under this type of plan, when the first spouse dies (let’s say it’s the husband), assets equal to his exemption from federal estate and gift taxes are placed in the first trust. The rest is placed in another trust for the surviving spouse or distributed directly to her. The widow can receive the income and principal if needed, but at her death the trust assets bypass her estate and go straight to the children or other beneficiaries. The point of the plan is to use the husband’s exemption from estate tax on the assets that pass to the first trust. Then when the widow dies, she uses her own exemption on the rest of the assets. The plan effectively doubles the available exemption. It made a lot of sense for many people when the exemption was $600,000 or $1 million or $2 million.

Being stuck with this plan, given the current federal estate tax exemption, is disconcerting. Estate plans that were very good when signed are now burdensome and unduly expensive because they set up trusts which no longer save any taxes they just cause extra administration expenses and hassle.

If you have an estate plan designed to take advantage of estate tax exemption and it was done before the exemption hit the higher levels, you need to have it updated right away. Many of my clients are doing this and are happy that they can now have substantially simpler plans.

Tune in next week for my conclusion.