This will illustrate how a hypothetical couple can substantially reduce their estate tax burden using a very common and well recognized AB will approach also called a unified credit trust which is a springing testamentary trust (lawyer for: its in your will, and it arises or "springs" in connection with your death).
For purpose of this illustration we will suppose a hypothetical couple in their 60s that have two children, who each have two children. The couple has a total net worth in the amount of $6,000,000.00 which includes the proceeds of a $2,000,000.00 life insurance policy on one spouse and a $1,000,000.00 life insurance policy on the other spouse and a marital residence worth $1,000,000.00. They want to leave everything to each other, then to the children. They also want to reduce the total estate tax burden which would be approximately $1,800,000.00 on the death of the second to die if they do no estate tax planning, execute a simple will and leave everything to their spouse.
The couple should begin to spilt assets for the AB will approach to work. Assets should be titled in the individual names of each spouse rather than joint name. This is one of the drawbacks to this approach. Frequently a couple has been happily married for decades, owns much of their real and personal property in joint name and there are emotional considerations with separating property. Other times one spouse has owned a business has earned significant amounts and nearly all the assets are in the name of one spouse. If asset splitting becomes too much of a problem for the couple then the estate tax savings may not be worth the emotional costs. To the extent these issues arise any client should feel to discuss them with their lawyer openly.
Unified Credit Trust
Lets assume our hypothetical couple is willing to split assets roughly equally between the spouses keeping some property such as the primary residence in joint name. That means that our hypothetical will each have roughly $2,500,000.00 in their individual names and the $1,000,000.00 home in joint name.
The unified credit trust is a so-called springing trust, that means that it is contained within one's will, and does not come into being or "spring" until the death of the testator (the person executing the will). In many AB will situations we leave the decision as to how much of the estate of the decedent to allocate to the trust until after the death of the decedent.
Lets assume that the first to die spouse dies in 2008 (when the unified credit is up to $2,000,000.00). Lets further assume that the survivor allocates the entire separate estate of the decedent up to the maximum of the unified credit ($2,000,000.00) to the trust contained in the decedent's will. That property passes to the trust with no estate tax consequence because it is exempt from estate tax by the unified credit of the first to die. The decedent is treated as half owner of the couple's $1,000,000.00 joint property, i.e. his estate has a value of $500,000, which passes estate tax free to the spouse due to the unlimited marital deduction. So there is no estate tax on the passing of the first spouse.
Lets assume that when the survivor dies, later in 2008, the survivor's estate is worth $4,000,000.00, ($2,500,000.00 of separate property plus $1,000,000.00 of joint property plus $500,000.00 of the decedent's separate property that was not allocated to the unified credit trust). In our hypothetical the principal amount stayed the same income earned by invested assets was offset by living expenses. The separate property, $2,000,000.00, of the first to die, allocated to the trust is not included in the estate of the survivor because it is not the property of the survivor. It is the property of a trust, specifically the unified credit trust in the will of the first to die. A trust out of which the income and certain distributions from principal can be paid to the survivor. A trust that benefits the survivor during the survivor's life and then benefits the children.
When the survivor dies the survivor's estate will have to pay some estate tax. The survivor's estate is worth $4,000,000.00. The tax will be approximately $900,000.00 after taking the survivor's $2,000,000.00 unified credit. Recall the the tax on a $6,000,000.00 estate if the couple had done no estate tax avoidance planning would have been roughly $1,800,000.00. The savings by using the AB will is an astounding $900,000.00, approximately. That is money that goes to your children and not to the IRS.
This type of estate plan can be put in place in our practice for less than $1,000.00. There are some disadvantages such as the asset splitting referenced above and the fact that a spouse at least in our practice cannot be made a trustee of the unified credit trust established in their spouse's will. That means that the spouses must select their trustees very carefully to avoid problems of access to money in the future. However, frequently the substantial estate tax savings is worth hurdles and costs of implementing this estate planning mechanism.
Please see our Diagrams page that further illustrates how estate tax savings can be accomplished by implementing an estate plan that includes wills containing unified credit trusts.
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