First, let’s look at the unlimited marital deduction—if you are a U.S. citizen you can leave an unlimited amount to your surviving spouse without owing estate taxes. So, for example, if Bill Gates were to die today and leave all of his billions of dollars of wealth to his wife Melinda, his estate could make use of the unlimited marital deduction and not pay any estate taxes. So far, it sounds pretty good, right? The problem is that everything will then be counted in the surviving spouse’s estate and will be subject to taxes.
Let’s go through an example. First, let’s assume that it’s 2013 and the estate tax exemption is $1 million. For our example, Bob and Susan are a married couple with $2 million total with $1.5 million being attributed to Bob’s retirement accounts, life insurance, etc. and the remaining $500,000 being attributed to the Susan.
Bob dies, leaving everything outright to Susan. He estate claims the unlimited marital deduction and no estate taxes are owned. Susan now has the full $2 million in her name. A few years later Susan dies and the entire $2 million is counted in her estate, but she only has a $1 million estate tax exemption. The end result? Susan’s estate pays $550,000 in taxes unnecessarily!!!
The good news is that a solid estate plan can include provisions to make sure that both spouses get full use of their estate tax exemptions so that as a couple, they can pass on more to their children without running into estate tax problems.
The key is that Bob should have left his assets to Susan in a special type of trust that would have permitted Bob’s estate to utilize his estate tax exemption and keep the funds from later counting as part of Susan’s estate. Different attorneys and financial advisors call these trusts by different names. In other offices, you might hear terms such as “credit shelter trust” or “bypass trust.”
Your surviving spouse can be the beneficiary of the trust, but it ensures that the assets in the trust will not have to be counted upon the surviving spouse’s death. If Bob and Susan had an estate plan that included such a provision, they could have easily avoided $550,000 in unnecessary estate taxes.