A marital trust, also known as a marital deduction, is an irrevocable QTIP trust that permits you to transfer assets tax-free to a surviving spouse. It can also protect the surviving spouse’s fortune before the remaining assets pass to their children. Knowing when and how to use a marital trust can have significant benefits for you and your family.
What Is a Marital Trust?
A marital trust is an irrevocable trust that allows you to transfer assets from a deceased spouse to the surviving spouse tax-free. The trust also protects the surviving spouse’s assets against creditors and future spouses.
Furthermore, when the surviving spouse dies, the assets under the trust are not included in their inheritance, resulting in fewer estate taxes.
As with other trusts, three parties are engaged in the creation, maintenance, and eventual transfer of the trust, including:
- Grantor: The individual who creates the trust
- Trustee: The person or entity in charge of managing the trust and its assets.
- Beneficiary: The individual will eventually inherit the trust assets after the grantor dies.
A marital trust also includes the principal, which refers to the assets placed in the trust at the start. These assets could be financial instruments that provide a steady stream of income to the beneficiary over time.
How Does a Marital Trust Work?
A marital trust can be established with the assistance of an estate planning attorney. All assets and property held in trust must be specified in the trust instrument. This can encompass almost anything valuable. This covers equities, bonds, mutual funds, cash, and real estate.
Trust assets flow tax-free to the surviving spouse upon the death of the trust grantor. This means that the IRS will not impose federal estate taxes on those assets. As a result, neither spouse must pay taxes on the transfer. This is made possible by Internal Revenue Code (IRC) Section 2056, popularly known as the “marital deduction rule.”
The surviving spouse can receive both income and principal from the trust. If a unique need arises, the trust grantor can give the trustee the authority to transfer some of the trust’s capital or initial investment to the surviving spouse. The creator of the trust might also grant the surviving spouse “general power of appointment.” This gives the surviving spouse the authority to direct the trustee to transfer trust assets. The grantor may, however, limit the withdrawal to a specific sum.
When the surviving spouse dies, the trust assets usually transfer to the couple’s children or other family members. However, the laws of various forms of marital trusts govern who can be nominated as beneficiaries after the death of the surviving spouse. More on that in a moment. For the time being, let’s look at some of the other estate planning advantages that a marital trust provides.
Why Create a Marital Trust?
A properly formed marital trust can give significant tax benefits to a family. As previously stated, a spouse can transfer assets tax-free to a surviving spouse.
When the surviving spouse passes away, the IRS charges the remaining trust assets to federal estate taxes. A couple, on the other hand, can benefit from the federal gift and estate tax exemption. This is the amount you can leave to heirs before having to pay an estate tax.
The new tax legislation that took effect recently effectively doubled that rate. Each year, it rises in line with inflation. So, in 2019, an individual can avoid estate taxes on $11.40 million. However, the tax law’s portability clause permits a couple to share their exemptions. A couple can shelter up to $22.80 million from the IRS with diligent estate planning.
In the case of a marital trust, here’s how it works. Assume the grantor leaves $10 million to the surviving spouse via a marital trust. Assume the surviving spouse leaves $15 million to the couple’s children through the same trust.
Even though the surviving spouse exceeded his or her individual exemption, the couple’s combined exemption ($22.80 billion in 2019) was not exceeded. However, in the absence of a marital trust, the surviving spouse’s estate would have had to pay federal estate tax on the amount transferred that exceeded the individual exemption.
Nonetheless, unless Congress acts to extend the federal gift and estate tax exemption, it will expire at the end of 2025. And tax regulations can alter even more during the lifetime of each married pair. When administering a marital trust, it’s usually a good idea to obtain the advice of a skilled financial advisor and an estate planning attorney.
When Should a Marital Trust Be Considered?
If you want to keep your wealth inside your family after you die, a marital trust is an estate planning strategy that will ensure persons outside of your family do not have access to the riches. A marital trust can hold a variety of assets, including real estate, retirement accounts, and investment accounts.
Other types of spouse trusts include a qualified terminable interest property trust (QTIP), a bypass trust, and a spousal lifelong access trust. These various trusts provide distinct tax benefits and require assets to be used in specific ways. To understand more about these various forms of spousal trusts, speak with an estate planner and a certified public accountant.
The Benefits and Drawbacks of a Marital Trust
A marital trust has several advantages, including the following:
- This will increase your estate tax exemption to $24.12 million.
- Give the surviving spouse an income and financial stability.
- Keep assets within the family.
- Keep your valuables safe from creditors and prospective new spouses.
- When the surviving spouse dies, the remaining beneficiaries may benefit financially.
However, like with any financial strategy, there are drawbacks to using a marital trust. Among the disadvantages are:
- Are irrevocable trusts, which means that once established, they are exceedingly difficult to dissolve or amend their rules.
- Only provide an estate tax exemption of up to $24.12 million.
- Require the transfer of assets into the trust, which can be a time-consuming process.
Read Also: Generation Skipping Trust: Definition and How It Works
How to Set Up a Marital Trust
A marital trust is a complex estate planning vehicle that should be carefully drafted. Because of the nature of the tax benefits, you should consult with not just an estate planner but also a certified public accountant to ensure the marital trust is correctly constituted.
After you’ve found the right people to work with, you’ll need to prepare a trust document. The grantor (you), trustee (who will run the trust), and beneficiaries will all be listed in this document. Marital trusts are irreversible, which means they cannot be dissolved once established. Keep this in mind as you build your marital trust.
How Does a Marital Trust Protect a Beneficiary From Death Taxes?
The Marital Trust enables a married couple to work together to maximize their joint estate and generation-skipping tax deductions.
Is a Marital Trust Required to Submit a Tax Return?
The Marital Trust normally uses the surviving spouse’s Social Security Number and is reported on their Form 1040, whereas the Family Trust obtains a new tax identification number (EIN) and is reported on a separate Form 1041 federal income tax return.
Can a Surviving Spouse amend the Terms of a Marital Trust?
Following the death of one spouse, the surviving spouse is free to change the conditions of the trust document that deal with his or her property, but cannot change the elements that govern what happens to the deceased spouse’s trust property.
Can Anyone Be a Beneficiary of a Marital Trust?
The only beneficiary must be the surviving spouse.
Can Only a Spouse be a Beneficiary of a Marital Trust?
Yes, the spouse must be the sole beneficiary in order to satisfy the estate and generation-skipping tax obligations.
Marital Deduction Trust
A marital deduction trust is a trust in which property transfers between married spouses are tax-free. A marital deduction trust can be either a life estate with a wide power of appointment granted to the spouse or a Qualified Terminable Interest Property (QTIP) trust.
The marital deduction trust protects both spouses’ assets and estates from federal estate taxes because when the first spouse dies, the assets specified by the settlor (the spouse who founded the trust) pass to the marital trust-free and clear of any federal estate taxes. Neither the settlor-spouse nor the surviving spouse pays property taxes. Furthermore, when the surviving spouse dies, the assets in the trust are not included in her estate, so her federal taxes are lower than they would have been if there had been no trust.
Marital Trusts and QTIP Trusts
A marital trust is a Qualified Terminable Interest Property (QTIP) trust. They are frequently utilized when a grantor has offspring from multiple marriages. The surviving husband is still the primary beneficiary. However, when the trust is established, the trust grantor might name a specific beneficiary or beneficiaries. This includes offspring from previous marriages, grandchildren, and anyone else.
However, during the surviving spouse’s lifetime, this beneficiary must receive the QTIP’s income at least annually.
As you can see, one of the key advantages of the QTIP is that the trust creator, rather than the surviving spouse, can name additional beneficiaries.
Other Types of Trusts
A family member may establish a personal trust and explicitly declare themselves as the beneficiary in addition to a marital trust. A personal trust can achieve a range of goals for one person or several. It can, for example, support education fees, meet heirs’ particular requirements, or allow them to avoid or decrease inheritance taxes.
Another alternative is to establish a bare trust, which is a sort of trust in which the beneficiary has an absolute right to the trust’s capital and assets, as well as any income generated. While a trustee is frequently in charge of overseeing investments under a bare trust, the beneficiary has the final word on how the trust’s capital or income is allocated.
Meanwhile, an alimony substitution trust is an agreement in which a divorced person agrees to pay spousal support using the money earned by the trust. In terms of taxation, the ex-spouse responsible for making payments is not required to pay income taxes on the trust’s revenue and does not qualify for a tax deduction.
Conclusion
A marital trust is a useful estate planning strategy that will provide for your surviving spouse after your death. By using this strategic strategy, you can effectively double the amount of your estate that will not be taxed at the federal level. You can also keep your fortune within your family by putting assets in marital trusts.
Marital trusts necessitate thorough tax and asset planning, so consult with a certified public accountant as well as an estate planner before establishing one.
Marital Trust FAQs
How do you create a marital trust?
A marital trust can be established with the assistance of an estate planning attorney. All assets and property held in trust must be specified in the trust instrument. This can encompass almost anything valuable. This covers equities, bonds, mutual funds, cash, and real estate.
What is the difference between a marital trust and a bypass trust?
The surviving spouse can usually access both the income and the principal balance of marital trust. The principle in a bypass trust, on the other hand, can be used for surviving spouse expenses such as health and support, but it is not normally accessible to the surviving spouse.
