Comprensive estate planning can help individuals and couples to maximize control over where their assets will go upon their death — while helping to mitigate 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. Although the U.S. Census Bureau’s definition of a family, “a group of two people or more (one of whom is the householder) related by birth, marriage, or adoption and residing together,” has not changed, its definition of married-couple families now includes same-sex married couples.
The Census Bureau also recently revised its relationship categories. The revised categories were used in the 2020 U.S. Census. Historically, only two classifications were included as relationship categories: Spouse (husband/wife) and Unmarried Partner. The revised categories clearly reflect the changing definition of today’s modern family and now include: Opposite-sex husband/wife/spouse, Opposite-sex unmarried partner, Same-sex husband/wife/spouse, and Same-sex unmarried partner.
As families evolve and rapid advances in reproductive technology continue, the question is: How can today’s modern families plan for their futures?
SAME-SEX MARRIAGES
With the dramatic ruling of Obergefell v. Hodges, the Supreme Court case which legalized same-sex marriage nationwide in 2015, the principle question surrounding marriage for many same-sex couples shifted from “Why can’t we get married?” to “Should we get married?” The following are some of the key areas in which same-sex marriage recognition affected a family’s financial situation.
Taxes
When the Supreme Court invalidated the Defense of Marriage Act in its 2013 United States v. Windsor decision, married same-sex couples became obligated, for the first time, to file their federal taxes jointly. Prior to the Tax Cuts and Jobs Act of 2017, it also subjected medium- to high-income earning couples to the so-called “marriage penalty,” which assessed married couples’ taxes at a higher rate than if the parties were single. Currently, the marriage penalty only applies to couples whose joint income falls in the 37% tax rate (taxable income over $647,850 for 2022).
Estate planning
Marriage offers some significant estate planning benefits to high-net-worth same-sex couples. The Supreme Court’s 2013 decision extended all of the spousal benefits in federal estate tax law to same-sex married couples. As a result, a surviving same-sex spouse is able to inherit his or her spouse’s entire estate without paying estate or gift taxes. They can also take advantage of estate tax “portability,” where a surviving spouse is able to use any unused amount of the other spouse’s estate tax exemption. Same-sex couples can now use gift splitting to give up to $32,000 per year to anyone they choose without triggering gift taxes. In addition, same-sex couples who live in states that once banned same-sex marriage can now pass their estates to the surviving spouse without any state estate taxes just like they can for federal estate tax purposes.
Social Security
Marriage can also enable a same-sex spouse to collect survivor benefits from Social Security. It no longer matters where the couple lives when applying for Social Security benefits. In the past, a couple had to live in a state that recognized same-sex marriage when applying for benefits.
Retirement planning
Same-sex marriages have the same status as opposite-sex marriages under ERISA and tax laws that govern qualified retirement plans, such as 401(k) plans and IRAs. A same-sex spouse has the same rights to benefits and retirement savings as any married spouse.
End-of-life care
Same-sex spouses have the same rights and responsibilities over health and financial decisions as traditional opposite-sex spouses. Although it is still important to have powers of attorney delegating authority over these decisions, the days of not being able to visit a spouse in the hospital or make critical choices about healthcare are over for same-sex spouses. Same-sex couples may now travel freely across state lines without having to worry about proving the legality of their marriage to make decisions for a spouse. However, it is still best practice for all couples, same-sex or opposite-sex, to periodically update and have easy access to their healthcare decision documents.
TRUST STRATEGIES FOR MARRIED COUPLES
The following are among the trust strategies worth considering for all married couples (whether same-sex or opposite-sex):
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
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 allow 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.
PLANNING STRATEGIES FOR NON-MARRIED COUPLES
Couples who aren’t legally married do still have access to trust strategies to reduce estate taxes and protect their partners and children. Indeed, it is as important for unmarried couples to review their estate plans to effectively use trusts as it is for married couples. In fact, married couples lost the use of the GRIT strategy explained below, which is only available to unmarried couples. Trust strategies that are appropriate to consider for unmarried couples, whether same-sex or opposite-sex, 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 non-married couples. 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.
Irrevocable Life Insurance Trusts (ILITs)
Couples who choose not 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. An ILIT is an irrevocable trust designed to hold ownership of an insurance policy. To create an ILIT, an individual establishes a trust and transfers funds to the trust. The trustee then purchases a life insurance policy payable to the trust upon the insured’s death. 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 $16,000 per recipient (2022). 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 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 managing the assets 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.
THE ISSUE OF “ISSUE”
Inheritance
The country has not had to grapple only 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.
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 (IVF) 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 is not always clear. About half the states in the U.S. explicitly recognize the rights of posthumously conceived children. These states typically have enacted time limits within which conception and/or birth must take place after the death of a parent (usually one to four years) for the child to garner inheritance rights, as well as other benefits. Otherwise, estates might be left open indefinitely. In order for an individual’s 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.
The rapid pace at which reproductive technology is advancing has also led to an increasing number of individuals storing genetic material to take advantage of IVF or surrogacy, not only to overcome infertility, but also simply to postpone childbirth until later in life or to help ensure fertility following a medical treatment. This means that people who die with stored genetic material is on the rise, increasing the number of potential posthumous births. As a result, grandparents writing trust documents, for example, need to consider that future generations of their family might use these technologies. They should consider defining the family members who can benefit from their trust assets in a way that accords with their intent (for example, defining their issue to include children born posthumously within a certain time frame). Absent 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.
Modern Families
When a couple, married or unmarried, is trying to conceive using new reproductive technologies, they are well-advised to consider what happens to any stored genetic material if the relationship ends in death, divorce or separation. The couple should memorialize their intent in an agreement, the contract with the fertility clinic and other estate planning documents.
If a couple using reproductive technology is not married, they should be mindful of their state laws, since the avenues to establish parentage rights can vary. It is in the best interest of the intended parents to consult with professionals in their specific state to ensure they follow their state’s guidelines. For example, an adoption proceeding or parentage judgment may be necessary for a non-biological parent to establish parental rights, from which inheritance rights flow.
THE DUAL NEEDS OF BLENDED FAMILIES
The modernization of the family unit and advances in reproductive technology are just two of the factors driving the transformation of the American family. It’s also important to consider today’s blended families that come together from divorce and remarriage – in some cases multiple times.
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 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 and Medicaid.
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 relinquishes 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 the trust creator’s lifetime and allows the creator, through the trust, to provide financial support while still alive. By contrast, a testamentary trust is established upon death.
THE IMPORTANCE OF PLANNING
Tax planning is just one part of estate planning, however. For non-traditional families — many of whom face myriad complex issues when it comes to providing for their loved ones after they are gone— planning remains as important as ever. Legislation, judicial decisions, and federal regulations serve as important reminders to have a timely and comprehensive plan in place.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. This article is not designed or intended to provide financial, tax, legal, investment, 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 not authorized to and does not provide legal, accounting, or tax advice. Our advice and recommendations provided to you are illustrative only and subject to the opinions and advice of your own attorney, tax advisor, or other professional advisor.
There is no assurance the any investment, financial, or estate planning strategy will be successful. These strategies require consideration for suitability of the individual, business, or investor.
The information in this article has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed.
Data source: www.irs.gov
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