Retirement assets can be quite a challenge in planning to fund a bypass trust. Portability can be a tremendous benefit to clients with large IRAs endeavoring to minimize estate taxes and still securing simplicity and preferable IRA treatment.
From a purely tax perspective (which is not always consistent with personal goals), leaving an IRA outright to a spouse is generally the preferred approach. This provides the surviving spouse the most tax flexibility and benefit. The increased $5 million exemption solves the entire issue for many clients, because their aggregate estate will no longer be subject to federal estate tax. But, for clients whose estate increases beyond this level, portability may be a great answer.
To maximize flexibility in this uncertain tax world, many advisers recommend the disclaimer approach. The client can bequeath all assets outright to his or her surviving spouse, who then, with the wisdom and judgment of hindsight can disclaim just the right amount to fund a bypass trust.
Example: Husband and Wife reside in New York, which has a $1 million state estate tax exclusion. Husband's estate consists of a house valued at $2 million, a $3 million IRA, and $1 million brokerage account. The house and brokerage account are owned jointly and Wife obtains title automatically by operation of law upon Husband's death. The IRA lists Wife as the primary beneficiary. Under Pre-TRA Wife would have to disclaim as the primary beneficiary of Husband's IRA. If Wife disclaimed, then the IRA would pass to a bypass trust under Husband's will.
Assume that Wife survives Husband, but based on the current 2011 $5 million exclusion, Wife determines not to disclaim any of Husband's IRA to fund a bypass trust under Husband's will. Her reasoning is that the aggregate estate is only $6 million, not much more than the $5 million exclusion. She anticipates spending down the estate over time to meet living expenses. If, in fact, her assumption proves correct, there will be no federal estate tax, although, there will be a moderate New York estate tax on her eventual death. However, more sound reasoning might suggest another approach. The estate may be valued at $6 million only because housing and security values are currently at depressed levels. If markets recover, the estate will almost assuredly exceed the $5 million exclusion even with a spend down. This will result in a federal and state estate tax. Post TRA, however, portability may enable Wife to avoid any federal estate tax.
Portability is not a cure all. Even if all the requirements (e.g., filing requirements) are met, state estate tax is not avoided because state law does not permit (yet?) portability. On this basis, Wife could at least disclaim $1 million of assets to remove those assets, and future growth in those assets, from her potentially taxable estate. At the $1 million threshold, she will reduce state estate tax on her death. Wife will also be able to reduce the federal estate tax.
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