Rethinking the 30-Year Old Pecuniary Marital / By-Pass Trust Formula

For the past 30 years the majority of married couple Wills (or revocable trusts) have included a marital / by-pass trust with a built-in mathematical formula. The formula determines what portion of the first-to-die spouse’s estate ends up in the marital trust versus what portion in the by-pass trust.

The by-pass trust under this longstanding formula ends up typically with the first-to-die spouse’s full available estate exemption amount plus the appreciation of the first spouses’ estate assets during the estate administration (prior to funding the trusts). The martial trust ends up with the balance.

The above 30-year approach is outdated in my opinion. Why?

It will produce in many cases unnecessarily increased income tax exposure from the compressed top marginal income tax rates applicable to trusts. It also will result in loss of a second stepped-up basis for the by-pass trust assets at the surviving spouse’s death.

Below is a more modern planning option:

This newer approach uses a pecuniary formula that gives the QTIPable marital trust an amount equal to the full value of the first spouse’s estate (not including qualified retirement accounts).   Essentially under this approach this QTIPable marital trust gets the entire first-to-die spouse’s estate based on the date of death value of the assets. By contrast, the QTIPable by-pass trust gets all the appreciation of the assets during the estate administration.

Why this newer approach?

One. This is an excellent design regardless of whether a married couple ends up over or under the inflation-adjusted $10 million combined estate exemption.

Two. This modern approach gives the surviving spouse the ability to choose full estate exemption portability of the first spouse’s estate, if desired. Portability can put into place a second stepped-up basis for the first-to-die spouse’s assets, again if desired. In addition, a full or partial QTIP election is available for either or both the marital trust and by-pass trust.

Three. This QTIPable trust design for both the marital trust and by-pass trust can include certain other bells and whistles so as to make either or both QTIP trusts defective for income tax purposes as to the surviving spouse. This helps reduce or eliminate the marginal income tax rate exposure.

Bottom line:

The above modern design provides optimal future flexibility that enables the surviving spouse to choose the best course of action for both estate and income tax savings, based on a response to the tax laws and circumstances at the first spouse’s death.

By contrast, the 30-year old marital / by-pass plan locks both spouses into inflexible options prior to the death of the first spouse. I general don’t like getting boxed in in this manner. Far too restrictive.

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