Creating a financial plan for retirement is one of the most important steps you can take as an engaged couple, a newly married couple, an empty nester, or even for those who are already retired. One of the options you may consider in your financial plan is setting up a marital trust. A marital trust is an agreement between two people that allows them to pass on their assets to the other party upon death or disability without going through probate court or incurring unnecessary tax liabilities.
Here is a complete guide to help you understand what a marital trust is and how it can benefit you both financially and emotionally when planned correctly by professional advisors.
Understanding Marital Trusts
A marital trust, also known as a marital deduction trust, is a type of trust that allows married couples to minimize or eliminate estate taxes on assets transferred to the surviving spouse. As a result, the surviving spouse has financial security and flexibility without being subject to immediate taxation.
When a spouse passes away, a marital trust can reduce the likelihood of estate taxes being incurred. As long as the assets are placed into a trust, the surviving spouse will not be subject to immediate taxation. Particularly for couples with high net worth, this can result in substantial tax savings.
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Types of Marital Trusts
There are two main types of marital trusts: the A-trust, also known as the marital deduction trust, and the B-trust, also referred to as the bypass trust or credit shelter trust. The A-trust allows the surviving spouse to access the trust’s assets during their lifetime, with the assets then being subject to estate taxes upon the surviving spouse’s death. Conversely, the B-trust is designed to bypass the surviving spouse’s estate, with the assets passing directly to the couple’s heirs, typically their children.
Establishing a Marital Trust
Creating a marital trust involves several critical steps, including drafting the trust agreement, funding the trust, and selecting a trustee to oversee its administration.
Drafting the Trust Agreement
The first step in establishing a marital trust is to draft a trust agreement. This legal document outlines the terms and conditions of the trust, including the distribution of assets, the appointment of a trustee, and any specific instructions or restrictions for the management of the trust. It is crucial to consult with an experienced attorney when drafting the trust agreement to ensure it complies with all relevant laws and regulations.
Funding the Trust
Once the trust agreement is in place, the next step is to fund the trust by transferring assets into it. This can include real estate, financial accounts, stocks, bonds, and other valuable property. It is essential to retitle these assets in the name of the trust, as this legally separates them from the couple’s individual estates and allows them to benefit from the trust’s tax advantages.
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Choosing a Trustee
A trustee’s responsibilities include managing the trust’s assets, making distributions to the surviving spouse, and complying with all legal and tax requirements. Trustee duties can be complex, so choosing someone with adequate knowledge and experience is important. The couple may choose a family member, friend, or professional trustee to serve in this role.
Advantages of Marital Trusts
There are several benefits to establishing a marital trust, including tax savings, asset protection, and control over the distribution of assets.
One of the most significant advantages of a marital trust is the potential tax savings. By utilizing the marital deduction, the assets placed in the trust can avoid estate taxes upon the death of the first spouse. This can result in substantial savings, particularly for couples with significant assets.
Marital trusts offer asset protection to the surviving spouse because the assets are generally protected from creditors’ claims and can be remarried or divorced with little consequence. Therefore, regardless of unforeseen circumstances, the surviving spouse maintains financial security.
Control Over Asset Distribution
By establishing a marital trust, couples can exert greater control over the distribution of their assets after their deaths. The trust agreement can specify the terms under which the surviving spouse can access the trust’s assets, as well as the ultimate distribution of those assets to the couple’s heirs. This can help avoid disputes among family members and ensure that the couple’s wishes are carried out as intended.
Potential Drawbacks of Marital Trusts
Despite their advantages, marital trusts also have potential drawbacks that should be considered before making a decision.
Legal and Administrative Costs
Setting up and administering a marital trust can be costly, particularly when it comes to legal fees and trustee compensation. These expenses may outweigh the tax savings for some couples, particularly those with more modest estates.
The legal and tax complexities associated with marital trusts can be daunting. Navigating these complexities requires a solid understanding of trust law and tax regulations, which may necessitate the involvement of professional advisors. This can be time-consuming and burdensome for some couples.
Alternatives to Marital Trusts
For couples who find that a marital trust is not the ideal solution for their estate planning needs, there are alternative options available.
The portability election allows the surviving spouse to use the deceased spouse’s unused estate tax exemption. This can provide tax savings similar to those offered by a marital trust but with less complexity and administrative burden. However, portability does not offer the same level of asset protection or control over asset distribution as a marital trust.
Irrevocable Life Insurance Trust (ILIT)
An ILIT is a type of trust designed to hold life insurance policies, with the trust being the policy owner and beneficiary. Upon the insured’s death, the policy proceeds are paid to the trust, which can then distribute the funds to the couple’s heirs free of estate taxes. While ILITs can provide significant tax savings, they do not offer the same level of flexibility or asset protection as marital trusts.
A marital trust can be a valuable estate planning tool for couples seeking to minimize estate taxes, protect assets, and exert control over the distribution of their assets after death. However, the complexities and costs associated with establishing and administering a marital trust may not be suitable for all couples. It is essential to consult with an experienced estate planning attorney to determine whether a marital trust or an alternative option is the best fit for your unique circumstances.