It May Be Time to Deconstruct Your Estate Plan
If you have any sort of sizeable estate and prepared your Will with an attorney’s assistance over the past 10 to 15 years, there is a reasonable possibility, especially if you are or were married with children, that your Will contained some fairly complicated wording. If the expressions “credit shelter trust,” “family trust,” “Q-Tip trust,” “A-B” Trust, or “disclaimer trust” ring a bell, the chances are that it might be time to reexamine your planning and decide how much structure you continue to need. You might decide, to coin a phrase, to “deconstruct” your estate plan to something simpler. I sometimes explain to clients they may not need a suit of armor after all if a tee shirt and shorts will do just as well.
This is not to say that there might be other reasons for a more involved estate plan. Since disclaimer trusts have an optional component, that is, the surviving spouse decides whether he or she needs it, and since Q-Tip Trusts have some special uses regarding division of property between spouses by later marriages and children by an earlier marriage, there may be reason to keep a more complicated plan but it still makes sense to take out the documents, look at them, and decide whether the complexity is necessary.
There is a solid reason for the observation that it may be time to simplify Wills and Trusts and I am not alone in making it. The Summer, 2012 edition of Pennsylvania Bar Association Newsletter of the Real Property, Probate and Trust Law Section, published an article by Sam Farkas, a Pittsburgh attorney with an LL.M. in Taxation, titled “The Death of the Formula Clause: Has this Venerable Estate Planning Tool’s Day Come and Gone.”
Formula (or Formulary) Clauses for Wills and Trusts were written to deal with federal estate and gift tax issues. They are more complicated than the simple wife to husband, husband to wife, on death of both of them to children Wills. They were drafted to save federal estate taxes. Now, only very large estates are subject to the federal estate tax, basically estates that, on the death of the second spouse to die are valued at more than $10 million or, as to individuals, estates of more than $5 million. The federal estate tax would apply to the amount that is above $10 million for those inheriting from the second to die spouse or above $5 million for an individual.
Since spouses do not pay estate taxes – they have an unlimited deduction -generally speaking, the federal estate tax is only a problem, if at all, if the children, on the death of the second spouse, inherit more than $10 million.
The older system of estate planning locks away a portion of the estate on the death of the first spouse so that it can be inherited later free of federal estate tax.
This is how a Formula Clause might read:
“I give to my spouse the minimum sum necessary to reduce my federal estate tax to the lowest amount possible and I give the residue to my credit shelter trust.”
Another version might state:
“I give to my credit shelter trust the amount of my unused exemption and I give the residue of my estate to my spouse.”
Other versions discuss “fractional shares.”
It might seem that this leaves the spouse with little after the death of the first spouse. However, the surviving spouse could be a Trustee of a credit shelter trust.
Before 2001 many relatively middle class estates fell into the category of needing federal estate tax planning. Without too much effort the combination of a house valued at say $350,000, life insurance for $300,000, and an IRA or 401(k) of $200,000 could begin to push the estate into federal estate planning for the excess. Because life insurance would be part of the estate for federal estate tax purposes, a mechanism known as an Irrevocable Life Insurance Trust (ILIT) came into existence to hold the life insurance and increase the value of the estate without itself being subject to tax.
If all of this seems complicated, it is. However, the point is that maybe it is not necessary to work so hard to save federal estate taxes. That has already been taken care of for most of us. It does not, however, save Pennsylvania inheritance taxes. That is a story for another day.
About the Author Janet Colliton
Esquire, Colliton Law Associates, P.C. Janet Colliton has practiced law for over 38 years, 37 of them in Chester County, Pennsylvania, a suburb of Philadelphia. Her practice, Colliton Law Associates, PC, is limited to elder law, Medicaid, including advice, applications and appeals, and other benefits planning including Veterans benefits, life care and special needs planning, guardianships, retirement, and estate planning and administration.