By, Addison Morton, Elder & Disability Law Clinic Student, Spring 2021
Preserving Your Estate for Those You Love
The primary motivation for most people in planning their estates is the protection of their family. There are real benefits of planning to ensure that your estate is distributed the manner that you desire and to the people that you choose. This blog post will discuss some specific strategies that will not only transfer your assets as you wish but will also protect and preserve your legacy for future generations.
One standard option in providing for spouses is a simple outright distribution of the entire estate to the spouse. While this is certainly an acceptable option, you should give some consideration to the possibility of your spouse’s remarriage or potential long-term care needs after your death. Additionally, if you have children from a previous marriage, you will likely want to provide for the comfort and well-being of your spouse during his or her remaining lifetime while also providing some protection for your children upon your spouse’s death. You certainly would not want your children accidentally disinherited because you died first, and your spouse remarried. Similarly, you may desire to divide your estate among your children but have concerns that they may squander the estate frivolously or lose it in a divorce.
Providing for the Surviving Spouse
With nearly half of all marriages ending in a divorce, it is not unusual for an estate to involve a second marriage, as well as children on either side from the prior marriage. Similarly, it is not uncommon for a surviving spouse to remarry upon the death of the first spouse. These circumstances require careful planning.
If you have children from a prior marriage, you are likely to be torn between your desire to protect and provide for your surviving spouse’s well-being and ensuring your children (not your spouse’s children) receive the remainder of your estate. These goals can best be accomplished through the use of a trust created for the benefit of the surviving spouse.
This kind of trust can either be a Testamentary Trust within a Will or a sub-trust contained within a Revocable Living Trust. Such trusts usually provide that the assets placed within the Trust are available for the benefit of a surviving spouse, but upon the death of that spouse, the assets are distributed to named beneficiaries. Frequently, the surviving spouse is named as Trustee of that Trust. On other occasions, one or more of the children are appointed as Trustee or appointed to serve alongside the surviving spouse as co-trustees. Sometimes a surviving spouse is named sole Trustee, but if that spouse remarries, their children are then designated as co-trustees. Institutions such as trust companies or banks are also appropriate to appoint as trustees.
The surviving spouse’s access to the trust assets may be unlimited; however, this would usually defeat the overall purpose of the Trust, which is to provide for and protect the inheritance of the deceased spouse’s children as well as the surviving spouse. Unlimited access would give the surviving spouse the opportunity to invade the Trust and distribute the assets upon that spouse’s death to that spouse’s beneficiaries. A more common approach is to give the surviving spouse all of the income from the family trust with limited access to the principal for such things as the surviving spouse’s health, or general support needs. This effectively gives the surviving spouse all of the excesses that they require but only for legitimate purposes. This would not permit the Trust to be raided for an inappropriate purpose such as transfers to the surviving spouse’s new spouse or transfers to step-children. This can serve to protect your children from your spouse’s remarriage while simultaneously providing for the needs of your surviving spouse. Just as importantly, it can also protect your surviving spouse from potential predators – those that might prey on a surviving widow for their own selfish purposes. The assets of the Trust would not be available, for example, to your surviving spouse’s new spouse, should he or she choose to remarry after your death. Similarly, if the Trust is drafted properly, the trust assets can be made unavailable to your spouse for purposes of public benefit eligibility, such as Medicaid. In that manner, the trust assets would not be required to be spent on long-term care benefits for the surviving spouse but could be available for the spouse’s supplemental needs.
Likewise, a properly drafted trust can provide protection from a surviving spouse’s separate creditors. All of these provisions serve to both provide for the surviving spouse of the marriage yet protect the assets for the children of that marriage or prior marriage.
Estate Taxes
Because of increasingly higher exemptions, the threat of estate taxes on an estate is exceedingly rare. However, for estates valued greater than $5 million, some planning for possible estate taxes is still prudent. Currently, there is no Virginia estate or inheritance tax; however, the federal government has imposed a death tax of approximately 40% of the value of any assets exceeding $11.58 million (in 2020). That tax threshold is scheduled to be reduced to almost half of that effective January 1, 2026, unless Congress takes some intervening action before the sunset of the existing tax law. Accordingly, if you have a large estate and are married, there are certain additional planning opportunities that can effectively double the current applicable estate tax exemption. This tax minimization is accomplished through the use of the tax exemption credit for each spouse. In other words, each spouse is entitled to use their own exemption.
At the death of the first spouse, the estate can split assets between the deceased spouse’s and surviving spouse’s shares. The maximum value of the then-current exemption amount can be placed within a trust known as a Credit Shelter Trust in order to fully utilize the applicable exemption credit belonging to the first spouse to die. The remainder of the estate can be paid into a Marital Trust, which would qualify for an unlimited marital deduction. Thus, regardless of wealth, there would be no tax incurred at the time of the deceased spouse’s death. The assets in both the Credit Shelter Trust and the Marital Trust can be made available to the surviving spouse to provide for their care and support. However, upon the death of the surviving spouse, the assets contained in the Credit Shelter Trust would pass outside the surviving spouse’s taxable estate. The assets in the Marital Trust would be included in that spouse’s estate but would also be subject to that spouse’s separate exemption. Accordingly, an estate exemption can be doubled and passed to the children or other named beneficiaries free of any estate tax.
An alternative approach would be to file a tax return upon the death of the first spouse and carry or “port” over that spouse’s exemption to the survivor. This is referred to as the estate tax exemption “portability.” While at first glance this approach may seem more straightforward than the creation of separate Credit Shelter and Marital trust shares upon the death of a spouse, reliance on this planning tool alone may eliminate other planning objectives and could result in higher estate taxes under certain circumstances. Both approaches are appropriate tools to consider, and neither is objectively superior to the other. Planning of this nature is extremely complicated and requires significant forethought, but the potential tax savings in large estates makes the effort worthwhile.
Guardianship and Trust for Minor Children
If you have children younger than twenty-one, you should name the person or persons that you desire to become legally responsible for your children at your death. The legal title for this position is called a guardian. Following the death of both parents, a court will appoint a guardian to be legally responsible for any surviving minor children until they reach the age of majority. In Virginia, the age of majority is eighteen. Although a court is not legally bound by your choice or designation of a guardian or co-guardians, a testamentary statement by you declaring your selection for this role would only be ignored or overridden by a court if there was substantial evidence suggesting service by the named person was not in the best interest of the minor child.
Such a preference for a guardian is generally declared in your Will. In the absence of such a declaration, the court will be forced to choose among individuals who assert that they should be selected to serve. This frequently involves multiple parties seeking to fill this role. Without the guidance of your preference or intent, the court is forced to exercise its judgment as to whom it thinks would best serve the interests of your child, without the benefit of your knowledge, observations, and preferences.
Distribution of Assets to Minor
If assets are being transferred to the minor child, the court appointing the guardian for the child will also require the funds be paid into a conservatorship account. Such a conservatorship account will be subject to court oversight, and will often be limited to FDIC insured accounts, which severely limit the potential growth or income from the assets. Additionally, a conservatorship will require annual accountings reported to the court, wherein the court will approve, or in some circumstances disapprove, the chosen uses of conservatorship funds. In many cases, no funds can be spent out of the conservatorship account at all without a separate court order approving the expenditure of those funds. Obtaining such a court order requires filing a petition before the court, appearing before the court, and getting a court order, all of which costs the conservatorship money.
As an alternative, you can establish a Trust for the benefit of your minor children. Such a Trust would not be subject to direct court oversight and would allow you to determine what types of investments were most appropriate and how the funds could be used for the benefit of your minor children. It would also let you name the Trustee, who quite frequently is a different person than the person named as guardian for your minor children. Using a Trust for your minor children gives you control over how your assets will be handled for your minor children, as well as who will manage those assets, all without the limitations that a court is likely to impose.
Selection of a Trustee
With every Trust, a trustee must be appointed. In the case of a spousal trust, such as the Marital Trust or the Credit Shelter Trust for the benefit of a surviving spouse, the spouse can be named as the Trustee with certain distribution limitations in place, or a third party can be named with complete discretion over distributions. Frequently institutional trustees are selected, such as a bank trust department or separate trust company.
For children’s trusts the trustee selection can consist of all the children serving collectively as co-trustees or each individual child serving as Trustee over their own trust share. In the case of less reliable children you will always want to name a third-party trustee. This could be another family member, friend, or institutional Trustee. In cases where you allow your children to serve as sole Trustee of their separate share of their trust it would be advisable also to consider the appointment a distribution trustee to provide some limitation or expansion to the child’s control or right to distribution of assets.