Martin M. Shenkman, CPA, JD, MBA, PFS, AEP (distinguished), estate- and tax-planning attorney based in New York City. He is coauthor of Powers of Attorney: The Essential Guide to Protecting Your Family’s Wealth. ShenkmanLaw.com
Have your estate-planning tools turned against you? Can you trust your trusts to work as intended?
Estate-planning decisions that made perfect sense when you put them into place years ago might have been undermined by subsequent life events or changes in the tax code—and it’s easy to overlook the fact that estate-planning choices made long ago have been rendered obsolete.
Here are complications that could arise—or that have already occurred—with five common estate-planning tools and decisions and how to reduce the potential impact of each…
Spousal Lifetime Asset Trusts (SLATs)…when there’s risk of divorce. SLATs can be an effective way to remove assets from a married couple’s estate while still maintaining some access to those assets. It typically works like this: A husband sets up a trust that names his wife (or same-sex partner) as primary beneficiary…while that spouse sets up a different trust naming her husband as beneficiary. The assets placed in these trusts are removed from the couple’s estate, but the couple maintains certain access to the money because the partners are the primary beneficiaries of each other’s trusts. SLATs were particularly popular in 2020 and 2021 when wealthy couples were preparing for potential estate-tax changes under the Biden administration.
But: What if a couple that has set up SLATs later gets divorced? Not only would each former spouse now have a trust that names his/her ex as primary beneficiary, but they each would be legally responsible for paying the income taxes on a trust that benefits someone they’re no longer married to.
What to do: Couples who have not yet set up SLATs but intend to in the future may avoid this problem by having “floating spouse” clauses written into the trust language. Rather than identify a spouse by name as beneficiary, this clause names the primary beneficiary as “whomever I am married to,” automatically removing your ex if you divorce. You also might consider a self-settled domestic asset-protection trust (DAPT) of which you are named a beneficiary. Then if you have no spouse, you still can get access. Couples who already have set up SLATs without this clause will have to take into account the tax burden in any future divorce settlement.
Insurance trusts…when the heir divorces or faces lawsuits. An insurance trust—a type of irrevocable trust that contains a life insurance policy—is a popular option for removing assets from an estate. The children of the individual funding the trust usually are named as beneficiaries of the trust, with the assets traditionally distributed to them when they reach a specific age in early adulthood, perhaps 25, 30 or 35.
But: What if the beneficiary gets divorced or is sued after the trust assets have been distributed? Much of the trust’s assets could be lost.
What to do: If you have an insurance trust that will distribute its assets automatically when the beneficiary reaches a certain age, ask your attorney to decant it into a new trust that, instead, allows the assets to stay inside the trust for as long as state law permits. There’s no advantage to removing assets from a trust before they’re needed—that only exposes those assets to unnecessary risks. If your insurance trust was drafted within the past decade, there’s a greater chance that it already works this way—estate-planning attorneys increasingly have recommended this approach to their clients in recent years, but be safe and check this out.
Bypass trusts/credit shelter trusts …in the current era of exemption portability. The purpose of a bypass trust or a credit shelter trust was to preserve the estate-tax exemption of the first spouse to die. That allowed a married couple to leave up to twice the estate-tax exemption to heirs without incurring estate taxes. These trusts made a lot of sense for many families when the estate-tax exemption was low and before portability was enacted.
But: Federal tax law now allows estate-tax exemption “portability” for married couples—the portion of the exemption not used by the first spouse to die can be preserved without the help of a trust by transferring it to the surviving spouse. What’s more, the estate-tax exemption has been increased to almost $13 million, which is more than enough to allow the vast majority of couples to pass their estates to their heirs without paying any federal estate taxes. The
$13 million exemption is scheduled to drop to around $6 million in 2026, but that’s still plenty for most families.
These changes to estate-tax exemption rules have rendered existing bypass and credit shelter trusts unnecessary from a tax perspective (but they may still protect assets from creditors). In fact, they’re worse—they may create unnecessary tax bills and hassles. Assets placed in these trusts don’t receive a “step up in basis” upon the death of the second spouse—that is, their cost basis cannot be increased to fair market value—leaving heirs facing capital gains taxes that they wouldn’t have had to pay if the assets were not in these trusts. Plus, families that have trusts must file a separate tax return for their trusts each year—a pointless annoyance or expense if that trust is no longer useful.
What to do: If you have a no-longer-beneficial bypass trust or credit shelter trust and don’t need it to protect assets, ask an estate-planning attorney to review that trust’s language to see if it includes a safety valve that allows for the trust’s termination. If no such safety valve was included, ask if the laws of the state in which the trust was established provide a right to terminate the trust.
Survivorship/second-to-die life insurance policies…in the current era of high estate-tax exemptions. Families that expect their estates to face hefty estate taxes sometimes purchase life insurance policies to help their heirs pay those looming tax bills.
But: Estate-tax exemptions have risen from $675,000 in 2001 to close to $13 million today. As noted above, that $13 million figure is likely to fall in the future. But it should remain high enough that most households that bought insurance policies decades ago to help pay future estate taxes are not going to have to pay estate tax after all.
What to do: Stop thinking of this life insurance policy as a necessary component of your estate plan. Rather, with the help of your insurance consultant, start evaluating future policy premiums as investments that might or might not be worth making. Also ask your insurance pro to crunch the numbers to determine whether it makes financial sense for you to either continue funding the policy, stop funding it but keep it in force, or perhaps sell the policy altogether.
Designated agents…and the passage of time. If you have had powers of attorney drafted, you’ve selected someone to make important health or financial decisions for you in the event that you become unable to do so for yourself. If you rent a bank safe-deposit box, you might have named a deputy or agent who can gain access to the box in an emergency. If you have a long-term-care insurance policy, you might have designated someone to receive duplicates of important notices sent to you related to that policy. If you’ve started your Social Security benefits, you might have “advance designated” a “representative payee” who is authorized to assist you with future benefits decisions, should the need arise. And that’s just the start—over the decades, you may have selected people to represent your interests in a range of ways with a multitude of different accounts and policies.
But: The people you selected years ago might no longer be the best choices. Some might have moved away, died or given you reason to doubt their decision-making abilities. And even if everyone you picked is still a worthy choice, there’s a good chance that you named multiple people over the years. That forces a group to coordinate its efforts to make decisions on your behalf in an emergency, which is a less-than-ideal arrangement that could cause confusion and delay.
What to do: Review your policies, accounts and powers of attorney to see who, if anyone, you named to represent you in an emergency. Update these agent designations so they all name the one or at most two people who you currently consider best suited to the role. If you do name two people, these should be people who you not only trust to make wise decisions but also trust to work together seamlessly.