What About Your Spouse?
Estate Planning From Your Spouse’s Perspective

In conjunction with issue 7 of Insight, the National Academies Estate-based Philanthropy program has organized a series of seminars on Estate Planning from Your Spouse’s Perspective. The first of these seminars took place during the NAS Annual Meeting in April 2002. A summary of that meeting follows, with links to corresponding audio portions available. (Audio clips require the RealPlayer, available for free here.)

Getting Started and Communication

A common question in estate planning is “Why do I need a Will?” More than just a tax planning device, a Will is a way to act on your personal goals, including assisting family members, giving to charities, etc.

Even if you already have a Will (or Revocable Living Trust), you should periodically revisit your estate plan to make sure it still reflects your personal and financial situation. Estate planning is a continuous process.

Before preparing or revising your Will, take a quick inventory of all your assets. Be sure to include homes, retirement plans, investments, and insurance policies.

This is also a good time to consider any special circumstances relating to your situation. Is there a family member needing special medical attention? Do you have any previous legal obligations to provide for someone?

The most important thing is to involve your spouse in all of these steps. Even if one member of the couple usually defers to the other in household financial matters, you should both be involved in the estate planning process. Otherwise, the surviving spouse may be at a severe disadvantage after the head of the household dies.

For more information, listen to the Getting Started, Communication audio clip (6 minutes).

Titling Your Assets

In conjunction with creating your Will, you should look at the way your assets are titled -- that is, who owns what.

If all your assets are jointly owned, they pass directly to the surviving spouse regardless of what your Will states. For this reason, and to minimize estate taxes, you should consider “balancing” your estate.

Ideally, each spouse would be the legal owner of enough assets to take advantage of the applicable exclusion amount, the amount you can pass on without incurring estate taxes. ($1 million in 2002. See this chart for details.) Otherwise, your heirs may unnecessarily pay estate taxes, greatly diminishing their inheritance.

Using Trusts

A certain portion of the assets of the first person in a couple to pass away are often bequeathed to a “family” trust, for the benefit of the children and other heirs. The surviving spouse may also have access to this trust.

This trust usually has assets equal to the applicable exclusion amount, allowing it to pass tax-free to heirs.

Any remaining assets are left to the surviving spouse. Though these assets may be given outright, for planning purposes it may be better to put the assets into a trust for the spouse. This will also help shield the assets from creditors.

Neither of these trusts will work correctly unless the assets are properly titled.

For more information, listen to the Titling Your Assets, Using Trusts audio clip (8 minutes). Near the end of this clip, it may be difficult to hear an audience member ask if the mentioned trusts are also known as the commonly used A-B trusts.

Homes and QPRTs

Many couples prefer to have joint ownership of their primary residence, oftentimes because of the emotional attachments associated with the home.

In cases where the home has significant monetary value, however, joint ownership may not be the best option. Much like the cases mentioned above, joint ownership may prevent you from taking full advantage of the applicable exclusion amount.

One way to reduce the tax impact of your home (or secondary residence) on your estate is to establish a Qualified Personal Residence Trust (QPRT). Basically, you transfer ownership of the home to a trust, but maintain an interest in the home, allowing you to live there for a number of years. If you survive that term of years, your home is out of your estate for tax purposes, and passes on to your designated beneficiaries.

If you wish to continue to living in the home after the term of years, you will have to pay a fair market rent to the beneficiaries. For this reason, many couples prefer to establish a QPRT for their vacation homes, rather than their primary residence.

Should you wish, you may designate a charity as the beneficiary of the trust. This is especially useful for couples whose children do not wish to be burdened with the upkeep and/or sale of the property.

Fiduciaries

Every estate will have an executor who will work with the family and advisors to settle the estate. If your estate plan establishes trusts, a trustee will make investment and distribution decisions for the trust. These executors and trustees are called fiduciaries.

Consider carefully who you choose to be fiduciaries. You may wish to name the surviving spouse or other beneficiary as fiduciary. Another popular option is to use a trusted financial institution as a fiduciary.

Regardless of which option you choose, you should allow for flexibility after your death, so your surviving spouse is not forced to work with a fiduciary he or she is not comfortable with.

For more information, listen to the Homes, QPRTs, Fiduciaries audio clip (10 minutes). It may be difficult to hear the audience questions at the beginning of this clip. The first question is about jointly owning a home. The second question regards living trusts vs. wills. The third refers to community property states like CA and WA.

Retirement Assets, Deferred Income

The largest asset in some estates are retirement assets, including qualified plans (IRAs, 401ks, etc.) and non-qualified deferred income, such as executive compensation or bonuses which have been deferred. The tax law is similar for both types of assets.

The most common beneficiary designation for retirement plans is the surviving spouse. There is no estate tax due, and the spouse can roll over the funds into an IRA.

However, some people would like those assets to go to a beneficiary of their choosing upon their surviving spouse’s death, rather than letting the spouse choose the ultimate beneficiary. In this case, the original owner of the plan can set up a trust as beneficiary, with the trust making payments to the surviving spouse for life, and then passing on the assets to the original owner’s chosen heirs.

Regardless, when it comes time for a non-spouse to inherit the funds from a retirement plan, they are susceptible to estate taxes. Income taxes will also be due, because these assets are considered “income in respect of a decedent.” The combined tax hit could be almost 70%.

Thus, many philanthropically minded individuals designate a charity as their retirement plan beneficiary. The charity pays no taxes, receiving the full benefit of the funds.

For more information on this topic, listen to the Retirement Assets, Deferred Income audio clip (9 minutes). The Questions audio clip (10 minutes) also contains more information about pension plans. Some of the questions in the Questions clip may be difficult to hear. The first questions all concern pension plans, and the final question is about the generation skipping tax.

Life Insurance

While insurance proceeds are exempt from income tax, they are not exempt from the estate tax. No estate taxes will be due when proceeds are paid to the surviving spouse, but when that individual passes away, any remaining assets will be susceptible to estate taxes.

Therefore, you may wish to establish an irrevocable trust as owner and beneficiary of the life insurance. Like the aforementioned trusts, the surviving spouse could have access to these funds, but, if designed properly, there would be no taxes due.

Couples with a philanthropic interest often use life insurance as part of a wealth replacement strategy. They donate an asset that would normally be taxable (e.g. retirement assets), and then buy life insurance to replace the value of that asset in their estate. Their heirs still receive the same amount, and the couple has helped a charity of their choice.

For more information on this topic, listen to the Life Insurance audio clip (5 minutes).

Second Marriages and “Blended” Families

Second marriages with children from previous marriages present unique challenges. Most individuals in this situation seek to provide for their children and their current spouse.

In some cases, a trust (as mentioned above) that provides income for the surviving spouse until his/her death, and then goes to the children, is an easy solution. In other cases, however, the current spouse may be close in age to the children from a previous marriage, meaning this trust effectively disinherits the children.

A compromise is to use some assets for a marital trust, while life insurance proceeds go to the children. This allows the children to get some money immediately.

Another common practice is to give the children assets valued up to the applicable exclusion amount, with the remainder going to the spouse. This will avoid estate taxes, but because the exclusion amount is scheduled to be increased (see this chart for details), the entire estate could go to the children, with nothing for the surviving spouse.

For more information on this topic, listen to the Second Marriages, "Blended" Families audio clip (4 minutes).

Charitable Considerations and Income for Spouses

Rolled over retirement plans and marital trusts are common ways to ensure a constant income stream for the surviving spouse. There are also several charitable options that can provide income.

Charitable remainder trusts (CRTs) and charitable gift annuities (CGAs) work in similar ways: you transfer assets now (or at death), receiving a charitable deduction for a portion of the transfer, and you or a beneficiary receives income for life or a fixed period of time.

Because the trust in the CRT is tax-exempt, it can sell appreciated securities free from capital gains taxes, allowing you to diversify your investments.

If you are interested in learning more about how a charitable gift can benefit you or your spouse and the National Academies, please contact us at giving@nationalacademies.org, or 202.334.2431.

For more information on this topic in general, listen to the Charitable Considerations, Income for Spouses audio clip (5 minutes).

Questions

During Q&A, the topic of pension plans was explored further.

In addition, a question was asked about the generation skipping tax. This tax is in addition to the estate tax on bequests to grandchildren. However, there is a $1.1 million exemption for the generation skipping tax, so very few estates are affected.

Listen to the Questions audio clip to hear all the questions and answers from the session in their entirety (10 minutes). Some of the questions in this clip may be difficult to hear. The first questions concern pension plans, and the final question is about the generation skipping tax.

For more information on any of these topics, please contact the National Academies Estate-based Philanthropy program at giving@nationalacademies.org, or 202.334.2431.