If you and your spouse are considering setting up a trust to manage and protect your family’s assets for future generations, you should consult with an estate planning attorney to gain a full understanding of your options. One choice you will be faced with is to create individual trusts for each of you or a joint trust.
While, as a couple, you may think a joint trust makes the most sense, the decision isn’t always that straightforward. There are many factors to consider before settling on your decision—such as where you live, the total value of your marital estate, and your relationship itself. Many couples consult with more than one attorney to get a feel for their style and type of advice. Only work with one that you are comfortable with.
To help make your decision a little easier, here are the strengths and weaknesses of each trust scenario, under different circumstances. But, first let’s review some definitions and key questions.
What is a joint revocable trust?
A joint trust consolidates a couple’s individual assets under one umbrella, so to speak. All assets within this type of trust belong to both spouses .
Most joint trusts are created as revocable, which essentially means the living grantors may modify, amend, or terminate the trust at any time. Grantors are the people who contribute money or property to the trust–in this case, you and your spouse.
When a couple is establishing a joint trust, each of them is considered a grantor. This means that both you and your partner can remove beneficiaries, designate new ones, and modify stipulations as to how assets within the trust are invested and distributed.
What happens to a joint trust when one spouse dies, or there’s a divorce?
If things go south maritally speaking, and you file for divorce down the line, the assets within a joint revocable trust are usually split equally between spouses—as simple as that. On the other hand, when the first spouse passes away, the assets become the sole property of the surviving spouse. Also, under today’s tax laws—which could change and should be verified in your state—typically half of the assets receive a step-up in cost basis at the first spouse’s death, meaning that the cost basis is changed to equal the value of the assets on the deceased spouse’s date of death. This can be a big capital gains tax savings if assets are then sold.
Effective July 1, 2021, Florida enacted new legislation becoming the fourth state to enact Community Property Trust legislation to enable married couples living in non-community property states to take a full step-up in cost basis upon the death of the first spouse.
A joint property trust may suit couples with uncomplicated estates, no prior marriages and the same beneficiaries and trustees. However, couples entering a second or third marriage later in life are likely to have substantially more separate assets and ideas concerning distribution to their separate families. In this case, setting up a separate trust fund may be a smarter option.
What is a separate property trust?
Separate property trusts keep one spouse’s assets distinct from the other. In other words, everyone’s property remains their own.
You may want to set up a separate trust to ensure your assets are managed according to your wishes after death or illness. For instance, you may want to ensure your money is passed on to your heirs. In many cases, the beneficiaries of separate property trusts are the children from a previous marriage.
At this point, you might be wondering, can a person have two trusts? For instance, you might want a joint property trust to manage assets acquired during your current marriage in addition to a separate property trust to securely distribute individual property to your children from a previous marriage. The answer is yes. However, caution should be used, and there are other ways to accomplish this. Your attorney will be able to provide guidance on this.
When does a joint revocable trust become irrevocable?
While the terms of a joint revocable trust can be changed at any time, an irrevocable trust cannot be amended, modified, or terminated, sometimes not at all, or sometimes not without the permission of the grantor’s named beneficiaries. Provided the joint trust was set up with both spouses as grantors, the trust generally becomes “irrevocable” only when both spouses die. However, It is possible for those who established the trust to set provisions that make the trust irrevocable after one grantor dies. For example, as both spouses age, you may grow concerned about undue influence from dishonorable family members or other predatory sources. Creating such provisions can ensure assets are passed on to your desired beneficiaries after your death. You attorney can work with you to craft appropriate language and explain any tax ramifications.
Separate Vs Joint Property Trust: Key Factors to Consider
Married couples often prefer joint trusts due to their ease of management and the simple fact that they support a traditional view of a marital estate as a singular unit. Although separate trusts offer some unique benefits for married couples, particularly in terms of management flexibility, asset protection, and potential savings of administration fees after the death of the first spouse.
Estate Tax Benefits
Separate trusts have federal tax advantages over joint trusts. Under federal law, separate property trusts provide tax benefits for wealthy individuals who own an estate worth more than the current federal estate tax exemption— $11.7 million per individual and $23.4 million per couple in 2021.
A joint trust can benefit from the same tax relief as a separate trust by converting the couple’s common property to separate property for gift tax purposes. However, this requires careful drafting by an experienced estate planning attorney and up-to-date knowledge of current legislation.
It’s also worth noting that if you live in a community property state listed below, a joint revocable living trust is possibly the best or only choice. This is because assets accumulated during the marriage are deemed joint property. Community property states are Arizona, Idaho, Louisiana, California, Nevada, New Mexico, Texas, Washington, and Wisconsin.
All marital assets in a joint trust are at risk if a creditor takes legal action against either spouse. However, in some states, there is an extended tenancy that may provide protection for the innocent spouse. Check out MO Rev Stat 456.950 and 765 ILCS 1005/1c.
Depending on state law, managing your marital estate in two separate trusts may offer better asset protection against creditors than joint trusts. Since the innocent spouse’s assets are in an entirely separate trust, creditors cannot gain access to the funds.
Couples generally find a joint trust much easier to manage and more flexible since all assets are combined. Provided you’re in a trusting relationship, each spouse can assume control over their individual assets within their joint trust and have an equal say in how the assets are managed—for example, how assets are invested and distributed.
Separate trusts can be more of a headache due to the sole fact that they must be managed individually by each spouse. However, the additional administration may be worth the hassle in certain situations. For example, a separate trust can simplify the management of any inherited property—such as a vacation home that has been on one side of the family for generations.
It’s also worth noting, should couples wish to combine their marital estate as a singular unit, they can still achieve this formality with separate trusts by naming each spouse as the other’s co-trustee. Co-trustees have equal rights and typically make joint decisions regarding the trust.
Management After the First Spouse’s Death
As mentioned earlier, ownership of a joint revocable trust generally passes to the surviving spouse. Depending on certain document details, the transfer of assets to remaining beneficiaries can be deemed a gift and may incur significant federal gift tax if large enough.
You can avoid this issue by giving each spouse the power to withdraw his or her separate trust property at any time without consent from the other spouse. This stipulation makes the potential gift incomplete and thus creates no gift tax liability. Your attorney can provide guidance for your specific situation.
Separate trusts tend to simplify and speed up the management of assets after the death of one spouse as assets are divided and distributed. Since quicker often means less expensive, this could result in more money going to the beneficiaries after estate management fees are incurred.
And of course, separate trusts give the grantor more flexibility and control over the designation of assets—who inherits what—and protects assets from future children should their spouse ever remarry.
The Bottom Line
Your final decision is a personal choice and may take some time to consider. Should you need any assistance navigating your marital estate, our team of financial experts at Castle Wealth Management are here to help as a member of your legal and accounting team.