A disclaimer trust is a term in a person’s will that creates a trust upon their death, subject to particular conditions. Certain assets can be transferred into the trust by the surviving spouse without being taxed. Furthermore, the clause may permit trust distributions to be made to survivors, such as young children. A disclaimer trust has its disadvantages, as well as its pros and cons. Read on to find out more.
What is a Disclaimer?
Inheritances are gifts. No one “has to” accept a gift. A beneficiary must “Claim” his inheritance. If a beneficiary does not desire an inheritance, he or she may “disclaim” it. A “Disclaimer” is when the beneficiary formally decides not to accept the bequest.
For example, the primary beneficiary on a father’s life insurance policy is his son, and the contingent beneficiary is his grandson. When Father dies, Son files a disclaimer with the life insurance company, waiving his right to the death benefit. Grandson inherits the life insurance proceeds.
For example, the family vacation property in Atlantic County, New Jersey is left to the wife if he survives, but to his son from a previous marriage if he does not. Following Husband’s death, Wife files a legal disclaimer, claiming the Atlantic County property. Son receives the vacation home.
What Is a Disclaimer Trust?
A disclaimer trust is a type of trust that incorporates embedded provisions, typically found in a will, that allow a surviving spouse to place certain assets in the trust by denying ownership of a portion of the estate. Property interests that have been reclaimed are then transferred to the trust without being taxed.
How Disclaimer Trusts Operate
If a person dies and leaves their estate to their spouse, the spouse may renounce part of the estate’s interests. These then pass immediately to the trust as if it were the original beneficiary.
Provisions in the trust can be drafted to provide for regular payouts from the trust to support survivors. A trust, for example, can provide for surviving minor children if the surviving spouse chooses to disclaim inherited assets and pass them on to the trust.
Disclaimer trusts oblige the survivor to act in accordance with the deceased’s desires and to relinquish ownership of some of the assets inherited by the deceased. In the preceding example, if the surviving spouse does not disclaim ownership of any portion of the estate, the deceased’s wish to transfer assets to the surviving minor children is not carried out.
A surviving spouse or the specified inheritors of an estate have a legal time limit. This is usually up to nine months from the date of death, to set up a trust for the disclaimed assets. If they do not do so, all assets contained in a will are taxed.
These trusts should only be established by trained lawyers due to the legal complications involved.
What is the Function of a Disclaimer Trust?
A Disclaimer Trust is a versatile tool that is frequently used when spouses want to leave all assets to each other in the event that one of them dies. The Wills are written so that all assets transfer to the surviving spouse. But, if the survivor disclaims, the asset goes into a protective trust for the survivor. In this manner, the survivor can benefit from the assets while keeping them safe from future creditors and disastrous marriages.
For instance, the husband’s will states that all assets pass to the Wife. However, if she disclaims any asset, the money goes into a Disclaimer Trust for Wife. Husband passes away. The wife has plenty of time to go over the assets and speak with her experts. In turn, she decides what is best for her. She may decide to seize all of the assets. She may, however, disclaim some or all of these assets. The decision is entirely up to the surviving spouse.
What she disclaims is deposited in a trust for her benefit, known as the Disclaimer Trust. Because she has never possessed these assets, they are now safe from her future creditors and spouse. When she dies, the trust can direct that the residual assets be distributed to the Husband’s children
In What Situations Should a Surviving Spouse Transfer Assets to a Disclaimer Trust?
When it is tax-efficient, a surviving spouse should disclaim an inheritance into a Disclaimer Trust. If, in our previous example, the couple with $1,350,000 has their estate reduced to $500,000, or they move to another estate without a state estate tax, or the estate tax exemption has increased far beyond what they expect to have when the surviving spouse dies, there is no point in the surviving spouse disclaiming.
If the surviving spouse is likely to live in a state with a state estate tax, and the surviving spouse’s assets (including the inheritance) exceed that state’s estate tax threshold, it is typically advantageous for the surviving spouse to disclaim the assets into a Disclaimer Trust.
(Incidentally, until the federal government allowed portability of the federal estate tax exemption between spouses, this was a part of almost every single Will for married couples.) Because of portability and the increase in federal estate tax thresholds, fewer attorneys are incorporating these clauses in wills. Unless, of course, the state levies an estate tax.
When Should a Surviving Spouse Transfer Assets to a Disclaimer Trust?
To be effective for tax reasons, a disclaimer must be filed within nine months of the date of death. The benefit of Disclaimer Trust planning for couples is that it allows the surviving spouse to consider all of the facts and circumstances when the first spouse dies.
It is critical to remember that funding a Disclaimer Trust is always an option. A disclaimer trust will not be financed unless the surviving spouse submits a qualified disclaimer in accordance with local state laws. You can assess your wealth situation, cash needs, and tax rules to determine what is best for your scenario.
What Are the Tax Implications of a Disclaimer?
If a Surviving Spouse disclaims during the nine-month period and follows the IRS rules (essentially, not receiving the property first, not directing where the disclaimed property goes, and complying with state rules on disclaimers), the disclaimed amount will be included in the decedent’s taxable estate. This is usually what you want because you are refusing to use the decedent’s estate tax exemption amount.
The person claiming must be careful not to claim too much. This may result in an estate tax being levied on the first to die.
It should be emphasized that failing to disclaim in a timely manner or in the manner prescribed by the IRS will result in the disclaimer being considered a taxable gift by the disclaimant. Essentially, the surviving spouse received the property and then gave it away.
Who Is Entitled to Make a Disclaimer?
I’ve talked about the capacity of a surviving spouse to make a disclaimer throughout this piece. While anybody can disclaim an asset, only a surviving spouse can disclaim an asset in a trust for the benefit of himself or herself. For anyone other than the surviving spouse, you cannot disclaim money and yet benefit from it. As a result, your child will never be able to disclaim into a trust for his or her own advantage.
On the other hand, attorneys frequently establish estate plans in which money is given to a child. However, if the child dies, her share is transferred to a grandchild in trust. If the child is wealthy, she may not want or need the money. In this case, the child can disclaim cash into the grandchild’s trust and function as trustee of that trust.
Pros and Cons of a Disclaimer Trust
A disclaimer trust has its own pros and cons:
Flexibility. The surviving spouse can choose to either take the inheritance or to disclaim it in a protective trust. After all, he already knows all the facts.
Some people do not wish to give their spouse a choice. They want the assets to pour into a protective trust. These people commonly use an AB Trust.
Disadvantages of a Disclaimer Trust
A disclaimer trust is not without its disadvantages.
The disadvantage of a plan like this is that the surviving spouse may choose not to execute a disclaimer and construct the Disclaimer Bypass Trust, and then later change the trust’s eventual beneficiaries. This danger is especially evident in plans that include remarried couples with children from previous marriages. After the first spouse dies, there is no guarantee that the surviving spouse will establish the Disclaimer Bypass Trust. This would safeguard the remainder beneficiaries chosen by the couple while they were both living.
A disclaimer may also be overlooked by a surviving spouse who lacks the capacity to sign a disclaimer document. However, with a properly designed Durable Power of Attorney in place, several practitioners are now advising clients that an A/B or Disclaimer Bypass Trust Plan is no longer necessary. The primary reason for this is that the Federal Estate Tax Exemption has now been increased to $5,250,000 per individual (2013). This, I believe, overlooks certain important benefits that this planning provides.
Alternatives to a Disclaimer Trust Plan
The question clients are routinely asked is if they want to ensure that the money goes into trust for the surviving spouse. If they want to guarantee the use of an estate tax exemption or protect the money from a future spouse, we wouldn’t do a Disclaimer Trust plan; instead, we would automatically fund a trust for the benefit of the surviving spouse upon the death of the first spouse, rather than giving the surviving spouse the option to fund it upon the death of the first.
Many people, however, are unconcerned about the surviving spouse remarrying and prefer to keep things simple. If there is a tax reason, we would usually allow the surviving spouse to disclaim their bequest into a Disclaimer Trust following the death of the first to die.
If the surviving spouse does not require the money, he or she may take it and give it to the children (or wherever you wish). Keep in mind that this could result in a taxable gift. However, because of the high estate and gift tax exemption levels ($11.2M per person in 2018), most persons will not have to pay a gift tax unless they make a very significant donation.
See-Through Trust vs. Disclaimer Trust
A see-through trust is another type of trust that allows assets to pass through to new beneficiaries.
A see-through trust, also known as a pass-through trust, allows individuals to transfer retirement assets from their individual retirement accounts (IRAs) to their designated beneficiaries through the use of a trust. See-through trusts use the beneficiaries’ life expectancies to calculate the required minimum distributions (RMDs) that will be made after the death of the retirement account holder. IRA owners have the option of designating a beneficiary, and federal rules restrict funds from being kept in perpetuity.
Disclaimer Trust and Inheritance
Disclaimer trusts, like other types of trusts, can raise issues regarding inheritance. These are normally explicitly stated in a grantor’s will; but, if a will is not finalized at the time of death, determining legitimate heirs becomes considerably more difficult.
Inheritances are usually taxed in most nations. An inheritance tax differs from an estate tax in the following ways: An inheritance tax would be levied against the heir who received the inheritance, but an estate tax would be levied against the assets of the deceased’s estate.
A Disclaimer Trust is an estate planning method in which a married couple inserts an irrevocable trust or revocable trust into their will that is only financed if the surviving spouse chooses to disclaim an asset. A Disclaimer Trust is self-funded, giving the surviving spouse unlimited flexibility. However, as you have seen in this article, a disclaimer trust has its disadvantages, as well as its pros and cons.
Disclaimer Trust FAQs
Is a disclaimer trust a bypass trust?
A Disclaimer Trust is just a voluntary Bypass Trust that the surviving spouse may establish after the death of the first spouse. Bypass Trusts, on the other hand, are required and must be established following the death of the first spouse.
Is a disclaimer trust a testamentary trust?
The disclaimer trust is a sort of testamentary trust. The disclaimer trust form is particularly appealing because it gives the surviving spouse options – typically, whether to have a trust or not, what assets to finance the trust with, and how much to put in the trust.