With the estate tax rate expected to range from 41 percent to 60 percent beginning in 2013, and with the exemption slashed from $5.12 million to $1 million at the same time, estate planning is as much about avoiding unnecessary taxation as it is about providing for your loved ones. Trusts can be a tool to achieve this. Marital trusts and family trusts work in tandem to save your estate tax dollars – when they’re done right.
Talk of trusts can give many people a headache because so many terms and names seem interchangeable. Marital trusts are sometimes called A trusts. Family trusts might be referred to as B trusts. A trusts and B trusts can stand alone -- you don't have to create both if that doesn't meet your needs. You can create either a family trust, a marital trust, or both by directing their creation in your will, or you can establish a revocable living trust to create them at your death. Your revocable trust might make some bequests from its assets when you die, reserving other assets that it then uses to fund a marital trust, a family trust, or both.
Saving taxes with marital and family trusts involves funding them according to the federal estate tax exemption – the portion of an estate's value upon which no taxes are due. It also means taking advantage of the marital deduction. If you do, both trusts avoid a maximum amount of taxation. The marital deduction allows you to leave unlimited assets to your spouse tax-free. You can fund your family or B trust with $1 million, the 2013 exemption, and if your estate is worth more than that, you can fund a marital or A trust with the balance. At the time of your death, the assets in your family trust are protected by the exemption, and the assets in your marital trust are protected by the marital deduction. No estate taxes are due.
Revocable Vs. Irrevocable Trusts
If the balance between a family and marital trust sounds too good to be true, that's because it sometimes is. The assets you transfer to the marital trust only escape taxation when you die due to the marital deduction. These can fall victim to estate taxes later when your spouse dies if the assets exceed the value of the estate tax exemption at that time.
It's often possible for your spouse to have some access to assets in the family trust after your death, but it doesn't usually work the other way around – your children or other beneficiaries don't benefit from the marital trust, at least during your spouse's lifetime. By definition, she is the only beneficiary of the marital trust and she must receive any income it generates while she's alive. Under some circumstances, she can also take some distributions from the marital trust's principal, as well as that placed in the family trust. Principal distributions must be in the interest of her health, education, maintenance or support, which covers a good bit of ground. Your other beneficiaries enjoy the same consideration from the family trust – they too can access the principal under certain circumstances if your trust documents provide for this.
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Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.