For many years, married couples commonly used A-B trusts to reduce estate taxes. When the first spouse died, the trust automatically divided, with some of the deceased spouse’s assets passing into a separate irrevocable Bypass Trust.
That approach made sense when federal estate tax exemptions were much lower. Today, the exemption is substantially higher, and federal law generally allows a surviving spouse to preserve the deceased spouse’s unused exemption through “portability.”
As a result, many couples no longer need a mandatory A-B trust. But tax laws and financial circumstances can change. Disclaimer trust provisions offer a flexible alternative—instead of requiring a separate irrevocable trust to be funded when the first spouse dies, the estate plan lets the surviving spouse create and fund one through a disclaimer if it makes sense at that time.
How Do Disclaimer Trust Provisions Work?
Suppose Jack and Susan have a $6 million estate. Their living trust provides that when Jack dies, his share will pass to Susan. But the trust also contains disclaimer trust provisions. After Jack’s death, Susan can accept the assets, or she can “disclaim”—decline to accept—some or all of them. If she makes a valid disclaimer, the disclaimed assets pass instead into a separate, irrevocable Disclaimer Trust under the terms Jack and Susan established in their estate plan.
Susan can still be a beneficiary of the Disclaimer Trust, although her control over its assets will be limited. When she dies, the remaining assets can pass to the couple’s children or other beneficiaries.
Importantly, Susan generally does not have to make an all-or-nothing choice. Depending on how the estate plan is structured, she may be able to disclaim only the amount that makes sense under the circumstances.
Thus, including disclaimer trust provisions in a living trust does not mean that a separate irrevocable trust will necessarily be funded. It preserves the option to fund one after the first spouse dies.
Why Is That Flexibility Valuable?
A couple creating an estate plan today cannot know what their circumstances will be when one spouse dies. Their $6 million estate might eventually be worth $4 million—or $20 million. Congress could increase or decrease the estate tax exemption. Their family circumstances could also change.
A traditional A-B trust generally makes the decision in advance—the Bypass Trust will be funded when the first spouse dies.
Disclaimer trust provisions preserve the decision until later—the Disclaimer Trust is funded only if the surviving spouse determines that doing so makes sense.
That flexibility can provide several advantages.
Potential estate tax savings. Assets placed into a properly structured Disclaimer Trust may remain outside the surviving spouse’s taxable estate. This can be particularly valuable for assets expected to appreciate significantly. For example, if $2 million placed into the Disclaimer Trust grows to $5 million during the survivor’s lifetime, the entire $5 million may potentially remain outside the survivor’s estate.
Flexibility without unnecessary administration. The couple can preserve the option to use an irrevocable trust without committing years in advance. If a Disclaimer Trust would provide meaningful benefits upon the first spouse’s death, the survivor can disclaim assets into it. If not, the survivor can accept the assets instead and avoid the additional administration, tax filings, expenses, and restrictions associated with maintaining a separate irrevocable trust.
Protection for children and other beneficiaries. If funded, a Disclaimer Trust can help preserve assets for children or other beneficiaries while still allowing the surviving spouse to benefit from them. This may be useful if the survivor later remarries or family circumstances otherwise change.
If protecting particular beneficiaries is essential, however, relying on the surviving spouse to make a voluntary disclaimer may not provide enough certainty. A mandatory trust may be more appropriate.
Why Might the Survivor Decide Not to Fund the Disclaimer Trust?
Estate taxes are only part of the analysis.
Assets included in the surviving spouse’s estate generally may receive a new income-tax basis when the survivor dies. Assets held in a Disclaimer Trust that are excluded from the survivor’s estate may not receive that second basis adjustment.
That creates a potential tradeoff. Keeping an appreciating asset outside the survivor’s estate may reduce estate taxes. Keeping it inside the estate may provide better capital-gains-tax treatment for the children.
For a family facing significant estate tax, funding the Disclaimer Trust may provide substantial savings. For a family unlikely to owe estate tax, retaining the assets may be more advantageous.
The benefit of disclaimer trust provisions is that this decision can be made after the first spouse dies, when the family’s actual finances and the tax laws then in effect are known.
There Is an Important Deadline.
This flexibility does not last indefinitely. To qualify for federal tax purposes, a disclaimer generally must be made in writing within nine months of the first spouse’s death. The surviving spouse also generally cannot accept the property or its benefits before disclaiming it.
Prompt legal and tax advice after the first spouse’s death is therefore important.
Disclaimer Provisions vs. Traditional A-B Trust
The basic distinction is straightforward.
With a traditional A-B trust, the couple generally decides in advance that a separate irrevocable Bypass Trust will be funded when the first spouse dies.
With disclaimer trust provisions, the couple instead chooses to preserve the option. When the first spouse dies, the survivor can assess the estate, current tax laws, financial needs, and family circumstances before deciding whether some or all of the deceased spouse’s assets should pass into an irrevocable Disclaimer Trust.
For many couples, that ability to decide later, with better information, is the principal advantage.
Is This Approach Right for You?
Disclaimer trust provisions are not necessarily better than a traditional A-B trust. The appropriate structure depends on the size and nature of the estate, expected growth, family circumstances, tax considerations, and the couple’s objectives.
For couples who want to preserve estate-planning options without committing today to a trust structure that may prove unnecessary years from now, disclaimer trust provisions can provide valuable flexibility.
Estate Planning at Mascaro Law Firm
Estate plans should account not only for today’s circumstances, but also for the possibility that financial circumstances, family needs, and tax laws will change.
If you have an older A-B trust or are creating an estate plan for the first time, Mascaro Law Firm can help you evaluate whether a traditional A-B trust, disclaimer trust provisions, or another approach is appropriate for your family.
