Estate Planner Nov-Dec 1997
A premarital agreement not only can ease family tensions that often occur in second (and third, fourth, fifth …) marriages, especially when children are involved, but also can help reduce estate taxes. How? The new spouse can agree to use his or her lifetime unified credit to transfer assets to the children from a prior marriage and agree to split annual exclusion gifts to them. Let’s compare this strategy with other options.
Because Terry, age 55 with two children from a prior marriage (ages 25 and 30) and an estate worth $6 million, plans to marry Leslie, age 45, with no children and a modest estate, Terry is creating a new estate plan with three primary goals:
1. Pass enough to Leslie to ensure that Leslie can maintain their lifestyle.
2. Pass more of the estate to the children.
3. Minimize estate taxes payable on Terry’s death.
Planning Without an Agreement
Distribute estate directly. Terry’s estate can be distributed equally among Leslie and the children on a pre-tax basis. This will reduce total taxes but leave more for Leslie than for the children. Leslie’s $2 million will qualify for the marital deduction, but the $4 million passing to the children will be included in Terry’s taxable estate. This will result in estate taxes of about $1.6 million and leave the children with only about $1.2 million each.
Distributing the estate so that Leslie and the two children will receive equal shares after taxes — about $1.33 million each — may be more appealing to the children, but will mean less for Leslie and about $400,000 more for the Internal Revenue Service, because the marital deduction is smaller.
Use a QTIP trust to defer estate taxes. Terry can create a qualified terminable interest property (QTIP) marital trust for Leslie and maximize estate tax deferral by allocating $5.4 million to the QTIP trust. The remaining $600,000 will go to the children. Leslie will receive all income from the QTIP trust and may receive distributions of trust corpus. On Leslie’s death, the remaining corpus will pass to the children. But, because of Leslie’s life expectancy, the remainder may pass to the children so far in the future that it will have a minimal present value, again, upsetting the children.
Purchase life insurance benefiting the spouse. Terry can purchase a life insurance policy to provide for Leslie and leave the $6 million estate to the children, who will receive $3.25 million after taxes, the same as if Terry had not married.
Purchase life insurance benefiting the children and use a QTIP trust. Terry can use the unified credit to fund an irrevocable life insurance trust (ILIT) for the benefit of the children. This may support a $4 million insurance policy on Terry’s life that will be out of the estate for estate tax purposes. As in the previous QTIP trust example, Terry can then leave $5.4 million to a QTIP trust for Leslie, thereby deferring all estate taxes and benefiting the children on Leslie’s death.
Planning With an Agreement
Agree to use the unified credit. Leslie can agree to use all or part of the unified credit (and perhaps the generation-skipping transfer tax exemption as well) to split gifts to the children. If Terry uses both unified credit amounts to fund an ILIT for the children, the $1.2 million can support an $8 million life insurance policy. Terry can then leave $4.8 million to a QTIP trust for Leslie, and no estate tax will be payable on Terry’s death.
Agree to make joint gifts. If Leslie also agrees to split annual exclusion gifts to the children, Terry can double the amount that can pass to the children each year tax-free.
Balance the Needs of Children and Spouse
With proper planning and a well-designed premarital agreement before a second marriage, you can meet the needs both of your children from a prior marriage and of your new spouse, and pass on more to your children at a lower tax cost. The agreement is not magic, but it does ensure everyone is on the same page. If you’d like to learn more, give us a call.