How can a “renunciation trust” help avoid estate taxes?

Including a renunciation trust in a will is an excellent way to help avoid estate taxes. Tax law allows a married person to leave an unlimited amount of property to a spouse without incurring estate taxes. Problems can arise with the death of the second spouse, not the first. For simplicity, assume that the husband dies first, and the wife second. When the wife dies, tax law currently allows one million dollars to pass through her estate to children or other beneficiaries without estate taxes. If the husband’s death put the entire combined estate into the wife’s name, then the wife’s estate may be over the limit. The husband’s exemption has been lost. Planning with a renunciation trust could have avoided this, preserving the husband’s one million dollar exemption and combining it with the wife’s one million dollar exemption, allowing two million dollars to pass without estate taxes.

A renunciation trust allows the surviving spouse (here, the wife) to take outright from her husband’s estate the amount up to her one million dollar exemption. She then “renounces” the rest of the husband’s estate into a trust. The wife can use the trust principal and interest for support and maintenance, even though she doesn’t own those assets. All of those assets the wife does not use will pass at her death from the husband’s estate (through the trust) to beneficiaries, not passing through her estate. The trust assets will not cause her estate to be over the exemption limit. More assets can pass to beneficiaries without estate taxes.

The beauty of the renunciation trust is that it has no disadvantages. If the estate is small enough not to trigger estate taxes, the wife takes all of the husband’s estate outright without renouncing anything. There is no reason to have the trust active if it doesn’t save tax dollars. If, on the other hand, the estate is large enough to cause tax concerns, the wife activates the trust. For that reason, I recommend including renunciation trusts in all wills for married couples. I do this even for young couples starting out, because the will may never be changed while their estates grow over time. The renunciation trust language only requires adding one paragraph to the will, so it is not complicated.

The advantage of activating the trust only if needed distinguishes the renunciation trust from other approaches, such as a credit shelter trust. In credit shelter trusts, the surviving spouse cannot opt out of the trust, but is stuck with it whether it is needed or not.

The one million dollar individual or two million dollar joint limit may not be as far off as one might think. Many ordinary people have a large life insurance policy or a large death benefit in a retirement plan. When such a life insurance policy or death benefit combines with the other usual assets, one can be over the limit before realizing it. An attorney can help choose estate plans based on your particular needs.

2411 Old NC 86, Hillsborough NC 27278 | Phone: 919-732-7300 | Fax: 919-732-7304 | Wordpress site design by LeGa Design Group