Issues INSIGHTS AND. Why Trusts Still Matter: The Brave New World of Estate Planning

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1 Issues AND INSIGHTS September 2013 Why Trusts Still Matter: The Brave New World of Estate Planning IN THIS ARTICLE Planning for same-sex couples after the passage of DOMA Understanding inheritance rights and posthumous birth laws Strategies for non-traditional and blended families Considering a loved one with special needs Mary Hickok Managing Director and Trust Counsel, Wilmington Trust Company Bruce Hoffmeister Senior Financial Planner, Sharon Klein Managing Director of Family Office Services & Wealth Strategies, Comprehensive estate planning allows individuals and couples to maximize control over where their assets will go upon their death while minimizing taxes so they can leave as much as possible to each other, their loved ones, and charitable causes. While this sounds simple enough, most laws regarding how estates are handled are designed with a traditional nuclear family in mind a husband and wife and their biological children. Today, fewer than half of all U.S. households meet the traditional definition, according to the United States Census Bureau, which found that the number of husband/wife family households declined to 48.4 percent in 2010 from 55.2 in The trend is likely to continue as same-sex marriage becomes legal in an increasing number of states, rapid advances in reproductive technology continue, and divorce and remarriage remain common. So how can today s families plan for their futures? Fortunately, recent changes in the law including the passage of the American Taxpayer Relief Act of 2012 (ATRA) and the Supreme Court s decision to overturn part of the federal Defense of Marriage Act (DOMA) are opening up new options for many families Wilmington Trust Corporation. All rights reserved. page 1 of 7

2 INCREASING RECOGNITION OF SAME-SEX COUPLES Perhaps the most seismic legal changes in the United States are occurring in the area of same-sex marriage. On June 26, 2013, in the case of United States v. Windsor 2, the United States Supreme Court found Section 3 of DOMA which denies federal recognition of same-sex marriages unconstitutional. As a result, the federal government must recognize same-sex marriages for couples who live in states where same-sex marriage is legal (so long as the marriage was performed in a state where the marriage was legal) and provide the same benefits including many related to tax and estate planning previously reserved for opposite-sex married couples. The federal government is quickly moving to extend the federal benefits of marriage to all legally married samesex couples regardless of where the couple resides, so long as the marriage was performed in a state or country where the marriage is legal at the time of the marriage. Benefits have already been extended to all same-sex married couples for the purposes of federal income, estate, and gift taxes; qualified retirement plans; immigration rights; military benefits; veterans benefits; and all federal government employee benefit rights. The Social Security Administration has yet to rule on the recognition of same-sex marriage for Social Security benefits for same-sex married couples living in the states that don t recognize same-sex marriage. Because of the difficulties of tracking the state of residence and administering benefits for same-sex married couples who move between same-sex marriage recognition and non-recognition states and countries, it wouldn t be surprising if the Social Security Administration acts to recognize same-sex marriage regardless of where the couple resides. Affluent married same-sex couples should review their estate plans to ensure that they are comprehensive and effective, and continue to review them regularly as the laws regarding same-sex marriage are rapidly changing. Planning Considerations for Same-Sex Married Couples The world of federal gift and estate tax planning dramatically changed for all married same-sex couples when the IRS announced on August 29, 2013 that same-sex marriage would be recognized for all federal tax purposes. For example, legally married same-sex couples, regardless of where they live, may now give property to a spouse during life or upon death free of federal gift or estate taxes by taking advantage of the unlimited marital deduction, a provision of the federal tax law that permits an individual to transfer an unlimited amount of assets to his or her U. S. citizen spouse, free from taxes, during lifetime, or at death. This provision allows a married couple to defer all federal estate taxes until the death of the surviving spouse. In addition, same-sex married couples may defer estate taxes until the death of the surviving spouse by taking advantage of portability, a feature of federal tax law made permanent under ATRA that allows a surviving spouse to take advantage of the deceased spouse s unused federal estate and gift tax exemption, in addition to his or her own exemption. The current available federal exemption for every person is $5.25 million. As a result, a same-sex married couple could leave up to $10.5 million to their children without paying any federal estate taxes. However, it s important to keep in mind that portability does not apply to the generation-skipping transfer tax. Affluent married same-sex couples should review their estate plans to ensure that they are comprehensive and effective, and continue to review them regularly as the 2013 Wilmington Trust Corporation. All rights reserved. page 2 of 7

3 In the wake of DOMA and IRS rulings recognizing same-sex marriage, same-sex married couples can now take advantage of several trust strategies that were once only available to opposite-sex married couples. laws regarding same-sex marriage are rapidly changing. The following are among the trust strategies that were once only available to opposite-sex married couples, but are now worth considering in the wake of the DOMA and IRS rulings recognizing same-sex marriage: Credit Shelter Trusts The most common type of trust created at death is a credit shelter trust. It uses the remaining federal exemption of the first spouse to die, while allowing the trustee to provide benefits to the surviving spouse (and sometimes, children) until his or her death, at which point the assets pass to the trust beneficiaries designated by the first spouse. Disclaimer Trusts After DOMA, same-sex spouses can take advantage of disclaimer trusts, which allow the surviving spouse to reduce federal estate taxes by putting inherited assets into a trust rather than taking ownership of them and receiving payouts from the trust. The estate plan of the first spouse to die provides that the surviving spouse takes everything outright. If the surviving spouse does take assets outright, those assets will all be taxed in the estate of the surviving spouse when that spouse dies. Instead, the Will allows the surviving partner to say I don t want the assets outright. I disclaim some or all of them. The estate plan of the first spouse to die has a credit shelter trust built in, so that any assets disclaimed pass to a trust for the benefit of the surviving spouse, using some or all of the federal exemption of the deceased spouse. When the surviving spouse dies, the remaining assets can pass to beneficiaries specified in the trust by the first spouse, estate tax free (including all of the growth during the survivor s lifetime). Qualified Terminable Interest Property Trusts (QTIPs) These types of marital trusts allows the first spouse to die to control the ultimate disposition of the property after the death of a surviving spouse while still taking advantage of the estate tax marital deduction and providing an income stream to a surviving spouse until his or her death. Upon the death of the surviving spouse, the future beneficiaries named in the trust become the beneficiaries of the trust. However, in this case, the tax is simply postponed until the death of the surviving spouse, at which time the survivor s federal exemption may be available to reduce the extra estate tax caused by the QTIP assets being added to the surviving spouse s assets for tax purposes. That s the good news. The bad news for planning is that the DOMA decision does not: make same-sex marriage legal nationwide; require non-recognition states to recognize same-sex marriages conducted in recognition states; address how the federal government should view domestic partnerships and civil unions; make clear whether the federal government should continue to recognize same-sex marriages of couples who relocate to non-recognition states for all the federal benefits of marriage (although the federal government is moving in the direction of universal recognition); or determine whether same-sex couples can divorce in nonrecognition states. Planning Strategies for Non-Married Same-Sex Couples Same-sex couples who aren t legally married do still have access to trust strategies to reduce estate taxes and protect their partners and children. It is just as important for unmarried same-sex couples to review their estate plans to effectively use trusts as it is for 2013 Wilmington Trust Corporation. All rights reserved. page 3 of 7

4 married same-sex couples. (In fact, same-sex married couples even lost the use of the GRIT strategy explained below, which is only available to unmarried couples.) The trust strategies that are appropriate for unmarried same-sex couples to consider include: Grantor Retained Income Trusts (GRITS) These types of trusts can only be established between individuals unrelated by marriage or birth and therefore, remain an effective strategy for all same-sex couples whose marriages aren t federally recognized same-sex marriages. GRITs can provide an income stream for the trust s creator while reducing estate taxes in order to better provide for his or her surviving partner or the children who are not the biological or adopted children of the trust s creator. The trust is created by one partner making a gift, but retaining an income stream for a term of years. The assets remaining in the trust at the end of the term pass to the other partner with no further gift tax. The IRS sets interest rates monthly, which control how much of an income stream will be retained by the partner who sets up the trust. If the assets grow faster than the IRS stated interest rate, the other partner or the children who are the future beneficiaries of the trust receive all the assets remaining at the end of the term free of gift and estate tax. Since the required interest rates have been very low in the recent past, and continue to be quite low, this structure can be very successful. Irrevocable Life Insurance Trusts (ILITs) Couples who are unable to marry and are therefore unable to take advantage of the unlimited marital deduction, which defers estate taxes until the death of the survivor might also consider establishing an ILIT in order to shield life insurance proceeds from federal estate taxes. ILITs have been a popular strategy for many years; gifts to cover the premium payments typically are made every year, and then at the death of the insured, the trust blossoms into the full face value of the insurance policy. The premium payments are often covered by the annual gift tax exclusion amount, currently $14,000 per recipient. If properly structured, the insurance proceeds are not taxable to the insured partner s estate, nor are they taxable when the surviving partner dies. This is particularly attractive when there are also children and grandchildren who are beneficiaries of this long-term trust. Living Trusts Popular for helping with incapacity planning before death, and avoiding probate at death, revocable living trusts function much like wills and can be particularly useful for same-sex couples who have reason to believe their wills could be challenged by family members. Assets are retitled into the name of the trustee, who is typically the person creating the trust. The trust has provisions that cover what the trustee may do with the assets during the grantor s lifetime (just about anything), but more importantly, it provides for the grantor and the grantor s partner and children during any period of incapacity prior to death. Because the trust already owns the assets, the successor trustee named in the document can take over in a smooth transition. At death, the trust has the same provisions that the grantor would have put in a will. This also avoids extra probate fees in many jurisdictions. Trust structures can also be helpful for same-sex parents when one parent is prohibited from legally adopting or sharing custody of a biological or adopted child of the other parent. In addition to naming the parent who has no adoption or custody rights as guardian for minor children, the couple might wish to name that parent as the trustee for a trust for the benefit of the children, which specifies how often the trustee must meet with the children, ensuring at least some visitation. THE ISSUE OF ISSUE The country is not only grappling with how to define marriage but also how to define children or issue for the purposes of estate planning. Advances in reproductive technology are creating once unimaginable questions regarding inheritance rights and have given rise to a new area of law: posthumous birth laws Wilmington Trust Corporation. All rights reserved. page 4 of 7

5 A posthumous birth is one that occurs after the death of one or both parents. Traditionally, this would refer to a situation when a father dies while his wife is pregnant or, less commonly, when an infant is delivered by Caesarean section after the mother s death. However, technologies such as in vitro fertilization and those that allow for the storage and even the posthumous extraction of genetic material mean that conception as well as birth can occur long after the death of a parent or even parents. While lawmakers debate the issues regarding posthumous conception and birth, the legal status of such children for the purposes of inheritance remains unclear. Some states are explicitly recognizing the rights of posthumously conceived children. These states have typically enacted time limits within which conception and birth must take place after the death of a parent in order for the child to retain inheritance rights, as well as other benefits. Otherwise, estates might be left open indefinitely. In order for specific wishes to be respected, it is important that wills and trust documents specify clear definitions for who would be considered issue for the purposes of, for example, trust payouts. While the idea of posthumous birth becoming commonplace may sound like science fiction, it is important to recognize the pace at which reproductive technology is advancing. Additionally, an increasing number of couples and individuals are taking advantage of it in some form perhaps to overcome infertility or to help ensure the ability to have children following a medical treatment or at an advanced age. As a result, grandparents writing trust documents, for example, need to consider that future generations of their family might use these technologies and plan their estates accordingly. In the absence of state law or a specific provision in a document, the rights of posthumously conceived children to be included as beneficiaries in an estate plan may be left to a court s interpretation of the trust creator s presumed intent. Today s non-traditional families include blended families due to divorce and remarriage. Trusts can help individuals in blended families provide for a current spouse while ensuring that assets ultimately pass to children from a previous marriage. THE DUAL NEEDS OF BLENDED FAMILIES The legalization of same-sex marriage in an increasing number of states and advances in reproductive technology are just two of the factors driving the transformation of the American family. Other forces include the country s rate of divorce and remarriage. According to the United States Census Bureau, at least one spouse was previously married in approximately 30 percent of marriages that occurred in 1996, 2001, and Spouses in blended families may wish to provide for a current spouse as well as children from previous marriages. Trusts can help achieve both goals. For example, individuals can use the previously mentioned credit shelter or QTIP trusts to tax-efficiently provide for a spouse while still ensuring assets ultimately pass to individuals of their choosing, usually the children from a previous marriage. PLANNING FOR A LOVED ONE S SPECIAL NEEDS No matter how a family is structured, creating an effective estate plan is even more complex when a loved one has a special need, such as a child with autism or even a spouse with dementia. Trusts can help ensure that loved ones are cared for and remain eligible for any government benefits to which they may be entitled. The most popular trust used in this type of planning is the aptly named special needs trust. This type of trust can hold a variety of valuable assets such as securities, real estate, and even a life insurance policy for the 2013 Wilmington Trust Corporation. All rights reserved. page 5 of 7

6 Special Needs Trusts can help provide for a disabled loved one without jeopardizing government benefits. comes to providing for their loved ones after they are gone planning remains as important as ever. Recent legislation, judicial decisions, and federal regulations serve as important reminders to have a timely and comprehensive plan in place. benefit of a disabled loved one. Because the trust owns the assets, if properly structured, their value is not included in the calculation that determines whether the loved one meets income-eligibility requirements for government benefits such as Social Security Insurance. Those setting up such a trust must decide how best to structure it. For example, whether to make the trust: Revocable or irrevocable. Making the special needs trust irrevocable requires that the trust creator permanently relinquish control of the trust assets in exchange for reduced estate taxes. Alternatively, one can give up some tax benefits to retain flexibility with a revocable trust. Inter vivos or testamentary. An inter vivos special needs trust is created during lifetime and allows the creator, through the trust, to provide financial support while still alive. By contrast, a testamentary trust is established upon death. AFTER ATRA AND DOMA The recent ATRA legislation and DOMA decision have helped inject an increased degree of certainty into planning. While ATRA makes permanent many of the most important estate tax benefits for married couples, the DOMA decision allows many same-sex couples to take advantage of them. This publication is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. This publication is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought. Wilmington Trust is a registered service mark of Wilmington Trust Corporation, a wholly owned subsidiary of M&T Bank Corporation. Investment management and fiduciary services are provided by Wilmington Trust Company, operated in Delaware only, and Wilmington Trust, N.A., a national bank. Loans, retail and business deposits, and other personal and business banking services and products are offered by M&T Bank, member FDIC. Tax planning is just one part of estate planning, however. For non-traditional families many of whom face a myriad of complex issues when it SOURCES: 1 United States Census 2010: c2010br-14.pdf 2 United States v. Windsor, 570 U.S., 133 S. Ct (2013) 3 us-remarriage-poster.pdf 2013 Wilmington Trust Corporation. All rights reserved. page 6 of 7

7 A WORD FROM OUR Family Governance Specialist: It s important with all planning matters no matter how your family is comprised to include ongoing education and communication as a key component. Keeping open channels of communication among family members is critical to helping sustain your wealth over multiple generations and in ensuring that your heirs understand and embrace your family s unique values, expectations, and philanthropic goals. Tom Rogerson Senior Managing Director and Family Wealth Strategist Wilmington Trust has been serving as a corporate trustee for more than a century, helping individuals and families translate their success into meaningful and lasting legacies. We understand that there is much more to managing wealth than simply managing money, and we are committed to helping you develop and implement the most effective wealth transfer plan for your unique situation. Please do not hesitate to contact your relationship manager, call us at , or visit our website Renowned Expertise: About our Authors Mary Hickok Managing Director and Trust Counsel Wilmington Trust Company Mary is responsible for developing and maintaining comprehensive estate plans for prominent individuals and families throughout the United States and abroad. She has more than two decades of experience as a practicing attorney and holds a Juris Doctorate from Widener University School of Law, and an LL.M. in Taxation from Georgetown University. Mary is also a graduate of the University of Pennsylvania with a bachelor s degree in International Relations. Bruce Hoffmeister Senior Financial Planner Bruce is responsible for providing comprehensive financial and estate planning advice to high-net-worth families and entrepreneurs in the Washington, D.C. Metro area. Bruce has more than two decades of experience in estate and financial planning for high net-worth families and closely held business owners. He holds a Juris Doctorate from the Washington University School of Law and a bachelor s degree in Accountancy from the University of Illinois. Sharon Klein Managing Director of Family Office Services & Wealth Strategies, Sharon provides comprehensive wealth management advice to high-net-worth individuals and families, entrepreneurs, business owners, and foundations and endowments throughout the New York Metro region. Sharon has more than two decades of experience in the area of trusts and estates and holds a Master of Laws degree from Boalt Hall School of Law at the University of California, Berkeley, and a Bachelor s of Law from the University of New South Wales, Australia. at wilmingtontrust.com if you have any questions or would like additional information Wilmington Trust Corporation. All rights reserved. page 7 of 7