Three Strategies That Add Flexibility to Your Estate Plan

In recent years, estate planning has been complicated by uncertainty over the future of the federal gift and estate tax regime. However, even when estate tax rates and exemption amounts are predictable, changing family circumstances make planning a challenge. Fortunately, there are several postmortem strategies a family can use to ensure that the deceased’s wishes are carried out. This article takes a closer look at three such strategies: disclaimers, limited powers of appointment and QTIP trusts.

Disclaimers
A disclaimer is an irrevocable, unqualified refusal by a beneficiary to accept a bequest, allowing the property to pass to another beneficiary. Normally, using a disclaimer to direct property to someone else would be considered a taxable gift, but there’s an exception for “qualified” disclaimers. To qualify, a disclaimer must:

• Be in writing
• Be delivered to the estate’s representative within nine months after the transfer is made
• Be delivered before the disclaimant accepts the property or any of its benefits
• Cause the property to pass to the deceased’s surviving spouse or to someone other than the disclaimant, without any direction from the disclaimant

This last point is critical and requires some planning on your part. To ensure that the disclaimant doesn’t direct the property’s disposition, the property must pass automatically to a contingent beneficiary according to the terms of your will or trust.

For example, let’s say Harry’s will leaves all of his assets outright to his wife, Sally, or in the event she doesn’t survive him, to their children. When Harry dies, his estate passes to Sally, and the unlimited marital deduction shields the entire amount from estate taxes. When Sally dies, however, her estate is subject to estate taxes because it exceeds her available estate tax exemption.

Suppose, instead, that Sally disclaims a portion of her inheritance equal to Harry’s available estate tax exemption. That amount then passes to their children estate-tax free by virtue of Harry’s exemption. The amount that goes to Sally is sheltered from tax by the marital deduction, and when she dies, some or all of it is sheltered by her own estate tax exemption. In other words, the disclaimer strategy can reduce or even eliminate taxes on the couple’s estates.

Limited Powers of Appointment
A “power of appointment” grants authority to designate the recipients of property held in an estate or trust. A power of appointment can create the flexibility to allow each beneficiary to make the best appropriate decision based on the information they have available rather than mandating a distribution scheme that may be inappropriate in the future.

A limited power of appointment does not allow the beneficiary to appoint the property to themselves, their estate, their creditors or their estate’s creditors. The use of a limited power of appointment allows the beneficiary of a trust to determine who gets the trust property next without having to worry about estate tax inclusion, as the trust property will not be included in the beneficiary’s estate upon their death.

For example, Harry’s will creates a trust for the benefit of his spouse, Sally, after his death. Harry grants Sally a limited power of appointment to distribute the assets remaining in the trust at her death among Harry’s issue (children, grandchildren, etc.) or to trusts for their benefit as Sally determines. If Sally does not exercise the power, the remaining assets are distributed outright in equal shares to Harry’s children. Harry’s son has developed a substance abuse problem. Sally exercises her limited power of appointment to appoint the share for Harry’s son to a trust for his benefit rather than leaving the funds to him outright.

QTIP Trust
Qualified terminable interest property (QTIP) trusts are often used to take advantage of the marital deduction while ensuring that assets are preserved for the children (particularly children from a previous marriage) and receive some creditor protection.

Ordinarily, to qualify for the marital deduction, you must transfer assets to your spouse with no strings attached. The QTIP trust is an exception to this rule. So long as your spouse receives all of the trust income for life and certain other requirements are met, you can enjoy the benefits of the marital deduction while still preserving assets for your children or other beneficiaries. When your spouse dies, any remaining trust assets pass to your beneficiaries but are taxed as part of your spouse’s estate.

Even if you don’t need a QTIP trust to protect your children or preserve your assets, it may still be a good strategy. Why? Because it creates opportunities for postmortem estate planning.

One of the requirements for QTIP status is that your executor or personal representative make a QTIP election on your estate tax return to have the marital deduction apply to the transfer to the trust. This gives the flexibility to make the election, not make the election or even make a partial election, depending on which strategy would produce the optimal results.

Suppose, for example, that when you die Congress has substantially increased the federal estate tax exemption. If the marital deduction isn’t necessary to avoid estate taxes, your representative might decline to file a QTIP election and instead apply your estate tax exemption to the transfer. That way, when your spouse dies, the trust assets will pass to your children tax free, regardless of any future changes in estate tax rates or exemption amounts.

Review Your Plan
Ideally, you should revisit your estate plan periodically and make revisions to reflect new legislation or changes in your personal circumstances. In addition, consider designing your plan to maximize opportunities for postmortem planning strategies, such as those discussed here.

If you have any questions on these strategies or other estate planning strategies, please contact me at (805) 963-7811 or ecole@bpw.com.