Disclaimer Dilemma

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Tax Trap

     How do married couples fail to maximize their federal estate tax protection? Consider the following case study.
     Husband and Wife have a combined estate value of $4 million. Wife has a $2 million QRP and Husband has $2 million in non-QRP assets. Wife selects Husband as the designated beneficiary of her QRP. When Wife dies, Husband inherits the QRP as an income-tax-deferred rollover. [Note: Only a surviving spouse may rollover an inherited QRP and continue to defer withdrawals until such spouse's own Required Beginning Date of April 1st of the calendar year after turning age 70^1/2.]
     Because of the Unlimited Marital Deduction there are no federal estate taxes due. But, this can be a tax trap. Any assets passing to a surviving spouse via the Unlimited Marital Deduction forfeit the Applicable Exemption Amount of the deceased spouse. Think of it as an unused, expired coupon. In our example, Husband now has the full $4 million in his estate. He can use only his own Applicable Exemption Amount "coupon," as his deceased wife's is no longer available. This may result in an avoidable federal estate (and income) tax liability.

Disclaimer CST

     Given the same basic facts as above, Wife could create a Credit Shelter Trust (CST).
     Under this approach, Wife would select Husband as the Primary Designated Beneficiary of her QRP and name the trust as Contingent.
     Upon Wife's death, Husband could disclaim the QRP, making the Credit Shelter Trust the designated beneficiary by default.
     Result: Wife's Applicable Exemption Amount would be applied to the value of her QRP (which Husband disclaimed to the trust). Husband can still have access to the QRP assets, however, as the trust beneficiary. The downside is that because the trust is not a surviving spouse, no rollover of Wife's QRP is permitted and income-taxable distributions must begin to Husband.
     While this technique may forfeit the income tax deferral available through the spousal rollover, it may achieve significant federal estate tax savings. Nevertheless, the Credit Shelter Trust Disclaimer alternative allows the surviving spouse to retain maximum flexibility over the couple's combined wealth and its ultimate disposition. Therefore, it is most appropriate in first marriages where any children are those of that marriage. Blended family situations, on the other hand, present unique planning challenges.

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