I’ve been practicing elder law and estate planning for about 20 years now. Many of the revocable trusts dating back to that time were created for estate tax reasons. But with changes in tax laws, those old trust protections can create new problems today.
The tax issues that my clients feared in the 1990s were quite real. The top federal estate and gift tax rate was more than 50% and an estate could only claim a $600,000 exemption. That was a real problem for clients with $2-$3 million.
The typical plan that attorneys drafted back then was two trusts, one for each spouse with the assets being approximately split between the two. Upon the death of the first spouse, the maximum amount based on the current exemption was put into a restrictive trust out of the estate of the surviving spouse called a “credit shelter trust.” The remaining amount in the deceased spouse’s revocable trust was passed to the surviving spouse, either outright or into a marital trust.
The idea was for both spouses to use their exemption, allowing them to pass twice the exemption, or $1.2 million, estate-tax free.
But times have changed. The federal estate tax exemption has risen to $5.49 million in 2017 and New York’s to $5.25 million. So now, only very wealthy people need tax planning to avoid or minimize such taxation. Most people have more modest wealth and do not need such restrictive estate plans. However, many people still have estate plans designed to fight taxes that no longer threaten their wealth.
I’ve seen two problems develop as a result. Let’s use the example of Mr. and Mrs. Smith, who have a total estate of $4 million. Everything is split so that there is about $2 million in each of their revocable trusts. Then Mr. Smith dies. In the plan described above, everything in his trust will go into a credit shelter trust since it’s less than $5.49 million, with severe limitations on Mrs. Smith’s access. Without this plan, Mrs. Smith would have gotten it all and would still be estate-tax free.
The smarter way of doing this is to use disclaimer provisions. This means that Mrs. Smith would get it all unless she disclaims or says that she doesn’t want any part of her inheritance from her husband. Then that disclaimed part, and only that disclaimed part, goes into the credit shelter trust. This works nicely if they think that their estate might grow past the exemption or if they fear that the next president might lower the exemption.
The other problem is when a surviving spouse needs nursing home care. Federal law says assets in Mr. Smith’s trust count as the surviving spouse’s assets for Medicaid nursing home benefit eligibility purposes regardless of trust provisions that restrict the surviving spouse’s access to the assets. That means they don’t care if it was moved into a credit shelter trust. So Mrs. Smith would have to spend down not only everything in her trust, but everything in his also. This is true whether the disclaimer provisions were in his trust or not. If there truly is no reason for the credit shelter provisions, Mr. and Mrs. Smith would probably be better off revamping their trusts for asset protection from long-term care and not worry about estate taxes.
These issues demonstrate why it’s advisable to review your estate plan at least every five years with an experienced trust and estate attorney to ensure that the plan still works under current laws and financial circumstances. Those people who made estate plans with wealth greater than $500,000 in the 1990s or more than $1 million in the early 2000s probably have unnecessarily restrictive trusts today. Remember, it’s relatively easy to update an outdated estate plan while you are healthy, but it’s virtually impossible to fix it after you die.