Essential Estate Planning Strategies for Married Couples

Estate planning doesn’t have to be a complicated ordeal full of words and concepts that only lawyers understand. For most married couples, there are two tools that are part of almost every estate plan and three trusts from which to choose one or more. They are the foundation of every estate plan. There are other features to add to make it complete, and as your estate gets larger you’ll want to consider more other tools and strategies. But even then the foundation of your estate plan still will be these two tools and one or more of these three trusts. Let’s take a look at them.

Marital deduction.

You can avoid all taxes on your estate by leaving everything to your spouse. Your estate would take what is called the marital deduction for the amount that your spouse inherits, and there is no limit to the marital deduction. You want to take advantage of the marital deduction to provide your spouse with the assets needed to maintain his or her lifestyle. It is a key feature of most estate plans.

Equalize your estates.

People tend to overuse the marital deduction. Leaving everything to your spouse only delays estate taxes. The spouse who is left with the entire joint estate must do some creative estate planning or pay that spouse’s estate will pay all the taxes on the joint estate. Using the marital deduction completely actually can cost your heirs taxes, because it means you won’t use other tools that are at your disposal.

Each spouse gets to pass up to $600,000 (indexed for inflation) tax-free to heirs besides the other spouse. This is known as the lifetime estate and gift tax exemption equivalent, or the estate tax credit. To take advantage of the exemption, each spouse must have legal title to $600,000 of assets. You’ve probably heard the saying that a married couple doesn’t have to pay estate taxes on the first $1.2 million of its estate. That’s true, but only if each spouse owns at least $600,000 of property.

That’s why couples need to equalize their estates. To get the maximum value out of your estates tax free, each spouse must be able to make maximum use of the exemption if he or she dies first. If the joint estate is worth over $1.2 million, each spouse needs at least $600,000 of property in his or her name. If the estate is worth over $600,000 but less than $1.2 million, neither spouse should own over $600,000. Shortly, I’ll show you some trusts that let you equalize estates while ensuring that each spouse is fully provided for.

Now let’s look at how these two tools can be combined with trusts to meet your estate planning goals.

The bypass trust.

The assets that are transferred to this trust by your will qualify for the estate tax exemption equivalent. It is called the bypass trust because the assets bypass the spouse’s estate. Other names are the credit shelter trust (because it uses the estate tax credit) and the A-B trust. You can eliminate taxes on your estate by leaving the maximum tax-free amount to the bypass trust and the rest of the estate to your spouse.

But the bypass trust need not leave your spouse in the cold. If your spouse needs the assets to maintain his or her lifestyle, you can provide that income and even principal from the trust will be paid to your spouse, either in specified amounts or as needed. It can pay income to your children or other heirs as needed while your spouse is alive. Then your heirs inherits the remainder after your spouse has passed away or under other conditions you set.

The bypass trust maximizes use of the estate tax exemption equivalent, ensures that your spouse is provided for, and also ensures that part of your estate will go to your children or other designated heirs. It limits the possibility that your wealth might go to the spouse or children of a second marriage.

Marital deduction trust.

As the name implies, this trust qualifies for the marital deduction. The spouse receives income from the trust as needed, and the spouse also can get the trust principal, even to the point of being paid the entire trust. Your spouse also can appoint who eventually inherits what is left in the trust. The entire trust is included in your spouse’s estate.

The real advantage of the marital deduction trust is that it takes management of the trust property out of the spouse’s hands and gives it to the trustee. The trustee can have discretion to pay or retain income and principal according to the guidelines you provide in the trust agreement.

Qualified Terminable Interest Property (QTIP) trust.

This is a special kind of trust that qualifies for the marital deduction if certain characteristics are present. In a QTIP, your spouse must receive all the income from the trust, paid at least annually. The trustee can dip into trust principal for your spouse under guidelines established by you. But your spouse has no rights to the property after his or her death. You decide how any remainder will be distributed to your other heirs. The trust property is included in your spouse’s estate when he or she dies.

The QTIP has several advantages. It qualifies for the marital deduction in your estate yet does not give your spouse full control of the property. That means you ensure that even if your spouse remarries, the trust principal will go to your children or whomever else you designate. Yet your spouse still will be adequately cared for. It often is used when one or more of the spouses is in a second marriage or is young enough that re-marriage is a real possibility.

A classic estate planning strategies for an individual with an estate between $600,000 and $1.2 million is to leave up to $600,000 of the estate in a bypass trust. This trust pays income as needed or an annual amount to the surviving spouse for life and allows the trustee to dip into principal for certain needs. After that spouse dies, the remainder goes to the children of the marriage. The rest of the estate is left to the surviving spouse in a way that qualifies for the marital deduction. It can be left directly. Or if there is a concern about the spouse’s ability to manage money or the possibility of a second marriage, it can be left in either a marital deduction trust or a QTIP trust. On a $2 million joint estate, this will cost about $320,000 in estate taxes but save over $268,000 in taxes.

Those are your basic clean, simple estate planning options. Everything else in estate planning builds on these. If your estate is not more than $1.2 million, you probably won’t need more than these basic tools. Larger estates need a few more strategies. But while you are trying to decide what other strategies to use, set up an estate plan using the basic tools until you are ready to supplement it.