Older Wills Need to be Reviewed Due to the New Tax Law

Some people have been reluctant to review their wills is recent years because the estate tax laws have been so uncertain. They’ve taken the attitude that they want to wait until the dust has settled.

Well, with the “fiscal cliff” law on the books, the dust has now settled – or at least things are far more settled now than they have been in a very long time.

That fact in itself is a good reason to have your estate plan reviewed. But you should also know that some of the provisions in the new law could wreak havoc with older wills that haven’t been looked at in a while.

Here’s just one example: A lot of older wills contain a “bypass trust.” For a long time, you could leave only a relatively small amount tax-free at death to anyone other than a spouse, so it was important to maximize this amount (called an “exemption”) for each spouse. Typically, when the first spouse died, an amount of assets equal to the exemption would go into a trust to benefit the surviving spouse and/or the couple’s children or other heirs, rather than directly to the other spouse. This way, the couple could use the exemption twice – once when the first spouse died, and once when the second spouse died.

As recently as 2001, the exemption amount was only $675,000, and the estate tax rate for amounts over that was 55%. So for larger estates, it was critical to maximize the exemption by having as much as possible go into a trust when the first spouse died, in order to “bypass” estate taxes.

Today, however, the exemption is $5.25 million, and that amount will increase each year for inflation. So if you have an older will that says the full exemption amount will go into a trust for your children, and the rest will go to your spouse, it’s possible that your entire estate will go into the trust, and your spouse will be left with nothing.

Therefore, it’s a good idea to review your will and reconsider the amount that should go into such a trust.

In fact, it’s possible that a trust is no longer necessary at all. Under the new law, if the first spouse to die leaves everything to the other spouse, the other spouse also inherits the first spouse’s exemption. Thus, when the second spouse dies, his or her exemption is doubled – for 2013, that would mean an exemption of $10.5 million instead of $5.25 million.

Leaving everything to a surviving spouse without a trust is simple, and it has a number of other benefits. For instance, when the second spouse dies, the couple’s heirs will receive a 100% step-up in basis for capital gains purposes on the entire estate.

On the other hand, there are many advantages to leaving assets in a trust. The assets will be more protected from creditors, for example. And if you have property that might greatly increase in value by the time the second spouse dies, you can avoid the possibility that it will exceed the exemption amount by leaving it in a trust.

If you’re concerned that your spouse might remarry after you pass away, or if you want to protect children from a prior marriage, a trust can be an excellent way to do so.

And a trust could also protect a surviving spouse from state estate taxes, which sometimes kick in at amounts that are far less than the federal exemption.

But a trust intended to serve one of these purposes might need to be different in structure from a traditional bypass trust, which is another reason that it’s important to have your will reviewed in light of the new law.