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What is Disclaimer Trust Planning?
A Disclaimer Trust is a type of trust that gets set up in a married couple joint revocable trust after the death of the first spouse. Its creation provides flexibility in planning for estate taxes, asset protection for the surviving spouse and protection for the first to die that his or her property will be passed to the beneficiaries originally selected and not to a new spouse of the surviving spouse. The surviving spouse has up to nine (9) months to execute a valid disclaimer under federal and California law to accomplish the set up of a Disclaimer Bypass Trust. IRC §2518. An attorney usually prepares this document for the surviving spouse to sign. The sooner this is done the better after the first spouse has passed away. The reason is because there are many ways that the surviving spouse might accidently blow the disclaimer (make the disclaimer invalid). One such way is by manipulating the assets or converting them into new investments. The surviving spouse may not change any of the disclaimed assets or benefit from them in any way until they have been disclaimed and have been moved over into a Disclaimer Bypass Trust. It is also possible to disclaim less that the total amount that the deceased spouse has left to the surviving spouse into the Disclaimer Bypass Trust. Unlike the traditional A/B trust plan model, a Disclaimer Trust plan affords the surviving spouse the opportunity to make a decision about the plan later on down the road. The surviving spouse can decide at the time their spouse dies whether or not they wish to create the Disclaimer Bypass Trust or simply allow all of the assets from their spouse to flow to them outright or in a Survivor’s Trust which they can amend or revoke at any time. The drawback of course to a plan like this is that the surviving spouse may decide not to execute a disclaimer and create the Disclaimer Bypass Trust and then later change the eventual beneficiaries of the trust. This risk is particularly apparent in plans involving remarried couples with children from prior marriages. After the first spouse passes, there is no guarantee that the surviving spouse will create the Disclaimer Bypass Trust which in turn would protect the remainder beneficiaries that the couple selected while they were both alive. A disclaimer could also be missed by a surviving spouse who lacks capacity to execute a disclaimer document. However, with a properly drafted Durable Power of Attorney in place, the disclaimer can be executed by a nominated Power of Attorney agent. As of late, some practitioners are counseling clients that there is no longer a need to set up an A/B or Disclaimer Bypass Trust Plan. The primary reason is because the Federal Estate Tax Exemption has now risen to $5,250,000 per person (2013). I think this fails to address some key advantages that this planning offers. Tax planning to take advantage of the first spouse’s exemption by placing assets into a Bypass Trust is just one of many advantages a Bypass Trust can provide to a family. Disclaimer Bypass Trust planning (as well as A/B planning) can provide the surviving spouse with asset protection and it can serve as divorce/remarriage protection from the surviving spouse’s future divorcing spouse. First, let’s address the asset protection planning that is available to the surviving spouse. If the surviving spouse executes a qualified disclaimer upon the death of the first spouse, he or she can wrap a layer of asset protection around the assets he or she disclaims and transfers to the Disclaimer Bypass Trust. Depending upon how the Bypass Trust is drafted, the surviving spouse can be the Trustee of that trust and have access to the principal and income from that trust during their lifetime for their own health, education, maintenance, and support. This is what we refer to as the “HEMS” standard. Generally speaking, it is a liberal distribution standard and covers most living expenses. An example of what it probably doesn’t cover is a trip to Las Vegas to play poker. But should the surviving spouse need money for food, medical, transportation, clothing, to buy a house, or even start a business, those types of distributions from the Bypass Trust to the surviving spouse are most likely going to pass muster. Where the asset protection comes into play is when the surviving spouse is being sued, is going through a divorce or has other creditor problems. If a creditor issue arises, the surviving spouse can resign as the Trustee of the Bypass Trust and appoint an Independent Trustee to guard and protect the assets of the Bypass Trust. The surviving spouse can even be given the power to remove and replace the independent Trustee. Another advantage to having a Bypass Trust is that the assets in the Bypass Trust will eventually be inherited by the original remainder beneficiaries of the trust that the couple selected because the Bypass Trust becomes irrevocable upon its creation at the death of the first spouse. This way the surviving spouse cannot change the beneficiaries later if he or she remarries and end up leaving the deceased spouse’s assets to the new spouse or the new spouse’s children. However, note that it is possible to give the surviving spouse a limited power of appointment to change the residuary beneficiaries of the Bypass Trust. An example of this might be to redistribute among the couple’s children or to change the way a child receives an eventual distribution. It is important to note that when doing Disclaimer Bypass Trust planning, it is not automatic. The surviving spouse (or his or her power of attorney agent if authorized) must make the election to disclaim and set up the Bypass Trust at the death of the first spouse within nine (9) months of the death of the first spouse. For couples wishing for this type of planning to be mandatory, an A/B trust structure is the better option. For more information on What is Disclaimer Trust Planning?, get a free copy of my book “Safeguarding the Nest, a California Estate Planning Guide, Third Edition” (2013) here or call (760) 448-2220.