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Five Reasons to Avoid Joint Living Trusts
Five Reasons to Avoid Joint Living Trusts
There has been much debate in the legal community over whether a married couple should use a joint trust or separate trusts to plan their estates. A joint trust is one trust document that contains the instructions for both spouses as to how assets are to be managed and distributed on disability or death. A separate trust, as the name implies, will generally contain the same instructions as are found in a joint trust, but each spouse has their own separate trust document.
As a general rule, there are five compelling reasons to utilize separate trusts over joint trusts.
1. Psychologically Neutral
First, some argue there is a psychological benefit to a joint trust – a marriage of love as well as a marriage of title. Proponents of joint trust suggest many married couples view separate trusts as a deviation from viewing their assets as “ours” as opposed to “yours” and “mine”. In our experience, we find this preference is more a reflection of the attorney’s preference than their clients.
However, this “concern” can be eliminated with the separate trust strategy by having both spouses serve as co-trustees of both trusts. The co-Trustee strategy results in no material distinction between each spouse’s ability to control trust assets - whether they were held in some form of joint ownership, in a joint trust, or in separate trusts.
2. No Tax Advantage to Joint Trusts in Separate Property States
Joint trusts are a preferable planning strategy for couples who live in or own assets in a Community Property state (California, Texas, Arizona, Idaho, Louisiana, New Mexico, Washington, Wisconsin, Nevada, and possibly Alaska). Property titled to a joint trust in a Community Property state retains its status as community property. By retaining community property status over trust assets, all assets in a joint trust receive a step-up in cost basis for federal capital gains tax purposes on the death of both the first and the second spouse (commonly referred to as a “double step-up in basis”).
This step-up enables a surviving spouse to sell assets after the death of the first spouse with a basis adjusted to the value of the asset as of the date of death of the first spouse. This has the potential to save significant amounts of capital gains taxes.
However, this capital gains tax advantage does not apply in Separate Property states (like Ohio and Florida for example). Indeed, in a Separate Property jurisdiction, only those assets that are attributed to the deceased spouse receive a step-up in basis (i.e. typically half the assets in the joint trust). The assets attributed to the surviving spouse receive no adjustment in basis on the death of the first spouse.
3. Separate Trusts Provide Superior Creditor Protection
One major benefit of separate trusts is increased creditor protection during the lifetimes of the Trustmakers. In a joint trust, if either spouse was sued, all of the joint trust assets would potentially be attachable by a creditor.
However, by having two separate trusts, if one spouse was sued, only the assets in that spouse’s trust would be exposed – even if both spouses were co-Trustees. The only scenario where both spouse’s assets would be attachable would be if both spouses were jointly liable to the judgment creditor.
4. Ease of Administration of Separate Trusts
Another advantage to separate trusts is that they are less burdensome and less costly to wind down upon the death of the first spouse. With joint trusts, on the death of the first spouse, all of the assets will need to be separated and assigned to either the deceased spouse or the surviving spouse for federal estate tax purposes.
This process of assigning assets is called “tracing”. Assets that are transferred into a joint trust during the lifetime of the Trustmakers retain the ownership character inside the joint trust. For example, if an investment account was previously owned by the wife and was later transferred into a joint trust, absent some language in the joint trust to the contrary, the investment account remains the wife’s asset even when owned inside the joint trust.
Thus, on the death of the first spouse, it will be important to “trace” the assets owned in the trust to determine how they were owned prior to being funded to the joint trust. If the Trustmakers did not keep detailed records of asset ownership pre-trust funding, the process of tracing the original ownership can be time intensive with increased attorney fees.
To compound the problem, the tracing process potentially necessitates significant assistance from the surviving spouse who is likely going through a difficult grieving process at the same time.
5. Separate Trusts are Easier to Amend After the Death of First Spouse
After the death of the first spouse, a joint trust becomes irrevocable. This may create challenges to amend the trust if there were changes in the law, family, or finances of the surviving spouse.
Thus, a joint trust potentially limits the convenience, flexibility, and control that a surviving spouse has over the terms of a joint trust after the death of the first spouse. Utilizing separate trusts will afford the surviving spouse the ability to make ongoing updates and revisions to their trust so their estate plan can continue to evolve to changing circumstances.
Of course, there may be legal or personal reasons for creating a joint trust as opposed to separate trusts in Separate Property jurisdictions. However, as a general rule, utilizing a Separate Trust for married couples who reside in a Separate Property state will afford significant benefits that cannot be achieved through the use of joint trusts.
Scott A. Williams has been recognized by Avvo.com as Supurb rated and a Clients' Choice estate planning attorney, as seen below:
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