Married Couple Trusts

What assets can you give away at your death? Under California community property law, individual spouses each own a half interest in their community property. Each spouse also owns his or her entire interest in any separate property (separate property is in general property owned prior to the marriage, property received by gift or inheritance). That means that each spouse may decide who receives his or her individual share of the community property at death.

Married couples setting up a joint trust have a threshold question to address: Do they each want to leave his or her share of community property to the surviving spouse in such a way that the surviving spouse has COMPLETE CONTROL over what happens to the deceased spouse’s (first spouse to die) share, OR would the couple prefer to lock up their shares in an irrevocable trust so that some control is maintained after death. The first option is known as a Survivor’s Trust or Power of Appointment Trust (POA); the second option is known variously as a QTIP, Bypass or ABC Trust.

Let’s look at this through a hypothetical couple.

Nancy and Jack are in their early 60s. They each have a child or children from a prior marriage, but there are no children of the marriage. Nancy has a son and Jack has a son and a daughter. All children are adults. The couple has been married 15 years and has significant community property. They each also came into the marriage with assets which they have mostly treated as separate property. Jack added Nancy to the title of his home after she sold her home, so they now consider the home they live in community property. Their estate is NOT subject to estate tax (so less than $11 million combined).

Nancy and Jack want to set up a joint trust. They are unsure whether to leave each of their assets outright to the surviving spouse at death. If they decide to leave all the assets to the survivor of them in a POA Trust, then all of Nancy’s assets would go to Jack (in a revocable trust) if she were the first to die. The final disposition at Jack’s death could be either the remaining assets are divided equally between the 3 children (1/3 each), or Nancy’s son could receive half the remaining assets and Jack’s 2 children would split half the remaining assets (so Jack’s son and daughter would each get ¼).

Since the POA trust is fully revocable and amendable, the surviving spouse – in this case, Jack – would have the ability to change the final terms. He could remarry and leave the assets to his new wife, or he could get dementia and make unwise financial decisions. The plus side of this kind of trust is that it is very simple to administer. The trust is not split into 2 shares after the first death, and there is no continuing administration (annual tax returns, accountings) for the life of the surviving spouse. Also many clients’ parents had this type of trust, so it can be a familiar option.

What if Nancy and Jack decide that they are more comfortable “locking up” each of their shares at death? Now say Jack dies first. At his death, Jack’s assets are transferred to an irrevocable trust – either a bypass or a QTIP (there are different tax issues for each, not discussed here). Nancy would receive all the income from the irrevocable trust, and as much principal from the irrevocable trust as she needed (she must typically spend down her own share of the assets first). At Nancy’s death, the assets of the irrevocable trust (Jack’s share of the community property plus any separate property he owned) go to the beneficiaries he chose – probably his two children. Any assets remaining in Nancy’s Survivor’s Trust (Nancy’s share of the community property plus any separate property she owned, basically all property that did not go into the irrevocable trust) go to beneficiaries of her choosing – presumably her son in this example. Or, if she has remarried, to her new husband possibly. Her Survivor’s Trust is fully revocable until her death as long as she has the legal capacity to make changes.

What is not discussed in this example: Funding the irrevocable trust and various tax issues related to holding assets in an irrevocable trust.