Joint revocable trusts: blessing or bane?

Kenneth P. Brier, BridgeTower Media Newswires

A friend from my childhood days recently asked me to review the estate planning that was in place for himself and his wife.

I looked at the documents, executed only a few years ago, and noted that they featured a joint revocable trust for the two of them. I have never utilized such trusts in my planning work, and have come across them only rarely except for new clients who have moved here from a community-property state (such as California). And the few “native” joint trusts that I have dealt with after the death of a spouse have been horror shows.

So this got me thinking: Aside from planning for clients in a community-property state (not something I would undertake solo), when would you want to use a joint revocable trust? What are the benefits? What are the risks and downsides? Does a joint revocable trust offer anything other than paper-saving?

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Appeal of joint trusts

The appeal of a joint revocable trust to a married couple is easy to understand. The arrangement to a layman’s eye looks a lot like joint property, which is similarly appealing.

For the couple, the arrangement bespeaks a financial partnership and sharing of property rights. If the spouses live their lives as an integrated economic unit and they intend to leave their wealth to the same people and in the same amounts, why not have a combined trust that reflects that reality?

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Joint trust essentials

A joint revocable trust commonly recites both spouses as the donors and provides for economic benefits to both while both are alive; for continuing benefits for the surviving spouse for his her remaining life; and for the remainder to pass to family members upon the death of the survivor.

Like the revocable trust created by a single donor, it commonly serves as the central document of the estate plan. Like the single-donor trust, it commonly is paired with a pourover will, in this case with the residue of each spouse’s estate passing to the same revocable trust.

Although the joint trust offers some of the flavor of joint property, it is not joint property. The trust property is governed by trust principles. Each spouse becomes a beneficiary of the trust. Each also is the donor of the trust assets to the extent of his or her transfers to it.

Each has an interest in his or her own contributions, as well as an interest in the other’s contributions (including a remainder interest contingent on being the survivor).

Each spouse becomes subject to all of the complicated income tax and estate and gift tax rules that apply to trusts. Therein lie multiple traps for the unwary.

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Joint trusts fitting the bill

Joint revocable trusts enjoyed a certain vogue a few years ago as an arrangement to facilitate a couple’s sharing of their federal unified credit amounts (“exemptions”), assuring the fullest possible utilization of those exemptions irrespective of the order of their deaths.

Most of the IRS private letter ruling blessing this particular planning scheme had involved joint trusts, though it could work equally well with separate trusts.

In any case, the introduction of exemption “portability” as of 2011 has effectively ended, for federal purposes, any need for this particular planning scheme.

For a couple without any significant estate tax issues, a joint revocable trust can work pretty well. At least initially, it may be easier to understand than two separate trusts, and it might be more easily funded if most of the couple’s property is jointly owned anyway.

Properly structured, a joint trust might provide a full step-up in basis of both spouses’ assets upon the death of the first spouse and again upon the death of the survivor, if each holds a general power of appointment over all of the trust assets at death. (But even with a general power of appointment, a full basis step-up is not assured under some technical rules negating a step-up for a surviving spouse who was deemed to have gifted property to the deceased spouse within one year preceding death.)

General powers of appointment should serve to avoid unintended completed gifts for estate and gift tax purposes and help maintain grantor trust status for income tax purposes, sidestepping income tax complications (at least if the couple files joint tax returns).

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Drawbacks

Joint trusts can undermine several of the non-tax advantages of revocable trusts as well.

Revocable trusts serve as an important backstop for the administration of an individual’s financial affairs should he or she become incapacitated during life. Though a joint trust might serve this same purpose, it seems preferable to more clearly distinguish the incapacitated spouse’s assets from the assets of the still-capable spouse. The desirability of distinguishing the spouses’ assets seems even more compelling if both become disabled.

Speaking of disability, the very people to whom the joint trust otherwise might be most suitable — couples with combined assets under $1 million — are also the ones most likely to need some kind of Medicaid planning. A joint trust would not satisfy any Medicaid planning desiderata, particularly if it provides very broad amendment, withdrawal and general-power-of-appointment rights.

Even before they evolved into tax (and Medicaid) planning tools, trusts were wealth preservation tools, separating the responsibility for managing wealth from the right to benefit from it.

Trusts have long protected beneficiaries from their own misfortune or folly. A joint trust is likely to minimize such protection. During the joint lives of the spouses, it may expose their combined assets to the claims of a creditor of either of them.

It will also offer little protection to the surviving spouse from creditor claims, and it will offer little to protect that spouse from the importuning of a new significant other (whether or not there is a remarriage).

In any case, you do not want a joint trust if the two spouses have different ideas about the eventual disposition of their assets. So in a second-marriage situation, you assuredly do not want to set up any new joint trust.

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When to hold ‘em, when to fold ‘em

The entire joint trust idea is grounded in an attempt to ignore the separate identities of the estates of two spouses. That is both its strength and its weakness.

To the extent that this idea jibes with the mutual attitudes of the two spouses and affirms their common plans, it can be a strength.

But to the extent that it serves to paper over real differences between the spouses, either in their attitudes or in the tax attributes of their property interests, it can create some real problems.

For the trust drafter, it is important that a joint trust not serve as a mental crutch. It should not encourage the drafter to gloss over the real design issues, which for a joint trust probably are even more subtle and arcane than for a single trust.

In general, a joint trust may work well for a couple with combined assets under $1 million who are not concerned about Medicaid planning. Other couples generally are better served by the creation of separate trusts.

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Kenneth P. Brier is a partner at Brier & Ganz in Needham. His practice focuses on tax and estate planning and wealth preservation matters.
 

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