Don’t Trust an Old Trust

My window on the world of estate planning has seen a lot of problems this year with old documents and documents drafted in other states. Some of the problems are the result of changes in tax laws. A plan which made sense 20 years ago makes little sense today. Other problems are related to the difference between Florida requirements and those of other states. All of the problems could have been avoided by periodic updates with an experienced estate planning attorney.

Revocable trust problems have been the most painful for clients. These folks spent a lot of time and money years ago to put together a comprehensive estate plan and did not think about the possible need to update. It is understandable how clients might believe once they devoted a lot of time and effort with an experienced attorney, their complete estate plan will last forever. All of the kids are still alive and none have problems. No thought is given to possible changes to will or trust. But when one spouse dies, problems become evident.

Many old revocable trusts were drafted with what is known as an A/B trust plan. Each spouse has his or her own revocable trust with a formula for what happens at death. The trust provides the maximum amount that can be given to beneficiaries other than the surviving spouse without imposition of estate tax is held in trust and the remainder is either given outright to the surviving spouse or held in a marital trust for the surviving spouse’s benefit.

These revocable trusts were usually drafted before 2013 and are intended to allow the estate of both spouses to claim the maximum federal estate tax exemption in effect at death of each spouse. The estate tax statutes were amended effective January 3, 2013, to make portability of each spouse’s estate tax exemption permanent. Portability means the estate of the second spouse to die can use the unused portion of the estate tax exemption from the estate of the first spouse to die.

Before portability, it was common to divide assets between spouses so that when the first spouse died assets remained in trust, the trustee could use the assets to benefit the surviving spouse, and at the surviving spouse’s death, the assets went to other beneficiaries (usually the kids). That allowed the spouses to each utilize the maximum estate tax exemption rather than having all assets pass to the surviving spouse and be stuck with only one exemption.

The estate tax exclusion was $675,000 in 2000. Legislation increased the exclusion to $3.5 million by 2009, $5 million in 2011 and it is now $15 million with future increase each year by inflation adjustment. With portability, a married couple can now shelter $30 million from federal estate tax without having to go through the trouble of separating assets. But many of those married couples have not revisited their documents. Those old documents can still provide the assets which they separated into each other’s trusts are not owned by the survivor when the first spouse dies but, instead, stay in the trust.

Even if the surviving spouse is named trustee of the trust, the trust must obtain a new federal identification number and be administered in accordance with its terms. Since the kids or others are remainder beneficiaries when the surviving spouse dies, even if the surviving spouse is given a great deal of discretion for use of funds in the trust, the surviving spouse is constrained by a duty to the ultimate beneficiaries. That can really be a problem if the survivor doesn’t get along with all of the kids.

What else goes wrong with these older trusts? To make sure there were no tax problems with a surviving spouse being trustee of the other spouse’s trust, many appoint someone to serve as co-trustee with the surviving spouse. That means the surviving spouse is not solely in charge but must work with someone else dealing with what the surviving spouse usually thinks of as the surviving spouse’s money. Not only has the surviving spouse lost his or her partner but has now also lost control of part of the family finances.

Some of the trusts have even more problems. In some cases, the trusts have been drafted in a manner that will require the trust pay income taxes. It is also possible the assets in the trust will not receive a step-up in basis when the surviving spouse dies.

Federal tax laws provide that someone inheriting an asset is treated for tax purposes as if he or she bought the asset what it was worth when the decedent died. That is a great tax benefit when the beneficiary later sells the asset as taxable profit is only the difference between what the asset was worth when inherited and what it sells for (as opposed to difference between what the decedent paid for it and what its beneficiary sells it for). If the surviving spouse owns everything, the kids and other beneficiaries inherit stock and real estate with basis of the value at decedent’s death. That benefit can be lost with these old trusts.

The trust of the first spouse to die is irrevocable and unchangeable by the surviving spouse. That can mean the surviving spouse has no ability to change who gets assets from the other spouse’s trust. The surviving spouse can control his or her own trust, but not that of the first spouse to die. That impacts ability to change distribution plan based on economics, deaths, births, medical concerns, or problems of a beneficiary not considered when the trusts were drafted years ago.

Revocable trusts are a great way to pass assets to people the grantor cares about. Trusts can avoid probate and allow for fine-tuning any distribution better than setting up transferable on death accounts and similar probate avoidance efforts. But old estate planning documents can outlive their usefulness or end up creating unanticipated problems if one adopts a “set it and forget it” approach. Estate planning documents should be considered living documents requiring periodic attention.