Disclaimers - Saying "No" to Your Inheritance
The New York Times ran an article this week "Saying ‘No Thanks’ to a Bequest". In the article, Deborah L. Jacobs explores how a disclaimer provision either included in an estate plan, or created after death, can achieve some estate tax savings in this environment of uncertainty about the federal estate tax this year or next.
In an estate plan a "Disclaimer" is when a beneficiary says "No, I don't want that part of my inheritance." Now, why would a person not want an inheritance? Well, for a spouse, a disclaimer is used more accurately to say "I don't want to take my inheritance outright, and therefore it should pass to a trust where I am a beneficiary." This trust could capture the exemption amount from federal estate taxes if and when the federal estate tax comes back. A disclaimer creates flexibility in a period of uncertainty as the spouse doesn't have to decide now if it makes sense to fund the trust, they can wait and see what the tax laws are at the time the first spouse dies.
The article outlines how a disclaimer works, the benefits of disclaimers (flexibility being key) and some of the drawbacks (what if the spouse doesn't disclaim, or accepts the assets so they can't disclaim). However, I think the article misses one key point about how using disclaimers to create trust can create inflexibility. If a person sets up a trust in their Will and directs that it be funded (i.e.: put $1 million is this trust) instead of allowing it to be funded through a disclaimer (i.e.: I spouse disclaim $1 million which will now pass to a trust), then the trust can give a person a "Power of Appointment" over the trust.
A "Power of Appointment" essentially allows a person to change who gets the trust funds and how after the death of the decedent. This is incredibly powerful in using a trust. A trust will last for years or decades after your death. Unless you have a crystal ball, you don't know what will happen to your beneficiaries, or what the tax laws will be in the future. By setting up a trust for your spouse and children, and giving your spouse a Power of Appointment, your spouse has the ability to change how your children eventually get your assets after your spouses' death. For example, if a child has a health issue, your spouse can change the trust to leave more to that child, or to leave it to the child in trust instead of outright. Without the Power of Appointment the child might get money that would negate other benefits he was receiving.
So how to balance the flexibility of a disclaimer with the flexibility of a Power of Appointment? In New Jersey, where we have a state level estate tax of $675,000, we recommend a "3-Part Will".
- Part 1 - An amount equal to $675,000 goes to a family trust with a power of appointment in favor of the surviving spouse
- Part 2 - An amount equal to the difference between (1) the federal estate tax exemption amount (if any) and $675,000 go to the spouse - the spouse can disclaim this amount to a family trust if it makes sense from an estate tax perspective
- Part 3 - The balance to the spouse