What Is a Marital Trust? Benefits, Types and How It Works

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If you’re married, you might be curious about what happens to your possessions once you or your spouse passes away. It’s part of being mature to plan for your future.

Several factors, including whether you have a marital trust, affect the answer to that question. You are also considering the size of your assets, the people who will become your beneficiaries, and much more.

It would help if you considered marital trusts in your estate plan because they have several advantages for the beneficiaries, such as asset allocation and tax advantages.

Let’s learn more about the different types of marital trusts and the pros and cons of having trust marriage policies.

What is a marital trust?

A marital trust is a legal entity that holds and manages one person’s assets for the benefit of another. Think of it like this, with a trust, you have a safe that holds your money and property for someone else.

So why have a trust?

• It can preserve assets for your children
• It can protect assets from potential creditors
• It can minimize estate taxes
• It can help avoid the costs and delays of probating a will
• It can shift part of your income tax burden to beneficiaries who are in lower tax brackets
• It can set up a support fund in the event you become incapacitated

Before you explore trusts, it is important to understand three terms associated with their construction:

1. A trustmaker is the person who creates the trust. This is also referred to as Trustor, Grantor or Settlor.
2. A trustee is the person or entity responsible for managing the assets that the trustmaker places in the trust.
3. A beneficiary is the person or entity identified to receive the benefits of the assets in the trust.

Don’t confuse marital trust vs family trust because they are different.

A family trust can be established during the spouses’ lifetime, whereas a marital trust can only be established to take effect after the first spouse’s death.

How marital trusts work

All assets and property the trust holds must be listed in the marriage trust document first. Almost anything of worth falls within this category. Stocks, bonds, mutual funds, money, and tangible property are all included.

Trust assets pass to the surviving spouse tax-free upon the trust grantor’s death. The IRS won’t assess federal estate taxes on those assets.

Marital trust taxation exemptions are a piece of good news because neither spouse will incur taxes on the transfer. The Internal Revenue Code, Section 2056, also referred to as the “marriage deduction rule,” has made this possible.

The trustee may transfer any portion of the trust’s primary or initial investment to the surviving spouse if a special circumstance arises.

The trust founder may also grant the surviving spouse “general power of appointment,” which gives the surviving spouse the authority to instruct the trustee to allocate trust assets.

However, the grantor can cap the withdrawal at a certain amount. What if the couple has children?

When a couple has children from a prior marriage and wishes to leave all of their assets to the surviving spouse upon death while also providing for each of their children, this is an example of when a marital trust might be employed.

The assets of a deceased spouse will go to their children instead of the new spouse if the surviving spouse marries again.

5 pros of a marital trust

A marriage trust can hold many assets, including real estate, retirement funds, and investment accounts. So, considering it is important, especially if you have huge assets.

However, we can’t just decide just because something is trending or sounds good. Like what we do with our investments, we need to know more about marital trust.

What are the pros and cons of marital trust? Weigh what works for you using the list below.

A marital trust can give you, your spouse, and your children security. There are many benefits to reap if you decide on getting a marital trust, such as:

1. You get to double your estate tax exemption amount to $24.12 million

Starting in 2022 and increasing to $12.92 million in 2023, the federal estate tax exemption shields $12.06 million from taxation. You can double your estate tax exemption if you have a marital trust. If you have bigger assets, this means a lot. 

2. Protection for all your assets

Should the remaining spouse remarry, all assets under a marital trust would be protected. This goes the same for the surviving spouse’s creditors.

This means you won’t have to worry that the new spouse will take all your hard-earned assets or creditors. It’s a good way to protect your assets.

3. Gives your surviving spouse financial stability and income

The death of a spouse can be too much; aside from that, the surviving spouse could have financial difficulties.

A marital trust can give a surviving spouse financial stability and compensation if those trust assets generate income.

4. Keep all your assets within your family

We want to protect our assets from creditors, future spouses, and others who might cut a portion of the assets left by a deceased person. A marital trust ensures that all assets will go to the deserving people within the family.

5. If the surviving spouse dies, it can provide stability to living beneficiaries

What if the surviving spouse also passes? What will happen to all the assets? The good news about a marital trust is that it can go to the surviving children or grandchildren if the surviving spouse dies.

5 cons of a marital trust

Employing a marriage trust has drawbacks, just as using other financial strategies. We must focus on more than just the good side of what is presented to us.

It’s also a must that we understand the cons that we may face when we decide on getting a marital trust.

These drawbacks include the following:

1. You can no longer change an irrevocable trust

While irrevocable trusts have many benefits, they also have their drawbacks. Once you’ve completed and transferred your life insurance policy to an irrevocable trust, you can no longer change your chosen beneficiary or borrow against the policy itself.

What if something unexpected happens? What if, in a rare circumstance, you want to alter your policy?

2. When your assets are placed in an irrevocable trust, they are no longer yours

Rethink twice or even thrice before you decide on your irrevocable trust because once it has been completed, all the assets you’ve declared on this policy are no longer yours.

This is why you have to think, assess, and even get the opinion of your trusted people before deciding.

3. You can only have up to $24.12 million in estate tax exemption

While we can view this as a benefit, it becomes a drawback if you have vast properties. Though, in some cases, you can get multiple trusts, depending on your needs.

4. You lose the rights to all income coming from your income-generating assets

Some assets are income-generating, which is very beneficial, as it could be a source of income and financial stability.

So you need to know that if you ever include this in a trust, you will also give up the rights to that income. Many people may overlook this and try to amend the trust later. However, that won’t work anymore.

5. You won’t be able to take control back if you change your mind

Contrary to a revocable trust, you cannot assume the assets if you develop a significant health condition that causes placement in a nursing home under federal Medicaid requirements.

Even if these are unforeseen situations, a signed trust is final.

How to create a marital trust

Before we go to the steps on how to create a marital trust, we need to know, “are trusts considered marital property?”

Unless they contain marital property, trust assets are typically seen as the specific property of the beneficiary spouse and are not subject to equitable distribution.

How should you start creating a marital trust if you are interested?

A marriage trust is a technical estate planning strategy that needs to be carefully drafted. You can’t just plan your marital trust. 

If interested, work cooperatively with an estate planner and a certified public accountant to ensure the marital trust is properly set up due to the nature of its tax benefits.

You must draft a trust document once you have identified the right experts to work with.

The grantor (you), the trustee (who will oversee the trust), and the beneficiaries are all addressed in this document. 

Because marital trusts are irrevocable, you won’t be able to change or revoke them after being established.

It would be best to have this in mind as you draft your marital trust. So, take time and ensure everything is understood before getting a marital trust.

Types of marital trust

To gain a better understanding of marital trusts, you need to look at the different types of marital trusts that are available and assess their specific features. Here are the different types of marital trusts:

1. Revocable trusts

“Is a marital trust revocable or irrevocable?”

Depending upon what your intent is will determine the type of trust you should have in place. In some situations, you may need multiple trusts. Three common types of trusts used with estate planning are revocable, irrevocable and testamentary.

A revocable trust (also known as a living or inter vivos trust) is one that you create while you are alive to own property and can be changed at any time. These trusts are important for the following:

• Planning for mental disability (thus the assets being managed by a disability trustee instead of a court-supervised guardian).
• Avoiding probate (thus allowing the assets to pass directly to the beneficiaries).
• Protect your property’s privacy and beneficiaries after you die (thus not making the distribution public).

2. Irrevocable trusts

An irrevocable trust can’t be changed after it has been signed after the trustmaker dies or after some other defined point in time. Three important functions of revocable trusts are:

• Asset protection (by placing the assets in the trust, the individual gives up their control over and access to the trust assets).
• Removal from personal assets (once assets are transferred to the trust, the taxes on the estate are reduced as they are no longer included as personal assets).
• Estate tax reduction (removing the property’s value from the estate so it can’t be taxed upon death).

There are some important factors to consider when creating an irrevocable trust:

1. When you create an irrevocable trust, your ability to control assets is lost and you can’t change your mind. There are potential opportunities to control what happens to the property in the future, but this must be clearly drafted in the trust.
2. If you experience a serious health issue that requires being placed in a nursing home, unlike a revocable trust, you can’t reassume the assets under federal Medicaid laws.
3. Life changes are inevitable and things that you thought wouldn’t happen may suddenly be desired but prevented due to the irrevocable trust.
4. If income is generated from trust assets, you lose the rights to that income.
5. Irrevocable trusts are subject to a gift tax when the assets are transferred into the trust.
6. The trustmaker can only add or amend something written in the trust.

Key differences between revocable and irrevocable trusts

Trusts are complex, and knowing which is best for you and your family requires close attention to detail and understanding your intent for the trust.

When considering the differences between revocable and irrevocable trusts, there are some key areas to consider: who controls the assets, whether trusts can be changed, the impact of estate taxes, how and what assets are protected, how it will impact you if you need Medicaid benefits and the impact on your income taxes.

The following is a quick overview of the differences between the two trusts.

• Controlling assets

Revocable: Trustmaker retains control

Irrevocable: Trustmaker loses control

• Revising the Trust

Revocable: Trustmaker can modify

Irrevocable: Trustmaker can’t modify

• Estate taxes

Revocable: Value of property included at time of death

Irrevocable: Not calculated in value of the property at death

• Asset protection

Revocable: Doesn’t protect from creditors

Irrevocable: Generally protected from creditors

• Medicaid planning

Revocable: Assets subject to Medicaid laws

Irrevocable: Assets not touched when obtaining benefits (assuming not transferred in the preceding five years)

• Income tax returns

Revocable: Taxpayer reflects everything on personal 1040

Irrevocable: The trust has its tax ID, files a 1041, and pays the taxes or issues a K-1 to trustmaker

3. Testamentary trusts

Unlike a living trust, a testamentary trust is created to go into effect when the trustmaker dies. This also applies to a trust created under a Last Will and Testament and can also be established under revocable and irrevocable trusts. In other words, this trust is not established and funded until the trustmaker has died.

Two common types of testamentary trusts are AB and ABC trusts.

• AB trusts are those often used by married couples to maximize federal estate tax exemptions for both parties. 

For example, when the first spouse dies, their revocable living trust directs that their assets will be divided to ensure the amount exempt from federal estate taxes is placed into a sub-trust (Trust B; also referred to as Bypass, Credit Shelter, or Family Trust) and anything over the exemption placed in another sub-trust (Trust A; also referred to as Marital, Marital Deduction or Q TIP Trusts).

These trusts are often popular with second marriages or marriages with a large age difference between the spouses.

• ABC Trusts are those used by married couples residing in states that collect state estate taxes, the exemption is less than the federal estate tax exemption, and the state permits a state Q TIP election. 

Effectively, this allows for maximizing the state and federal estate tax exemptions while deferring the payment of both state and federal estate taxes until the second spouse’s death.  

Connecticut, Delaware, Hawaii, Illinois, Kansas, North Carolina, Minnesota, New York, Ohio, Oklahoma, Oregon, Rhode Island, Tennessee, Vermont and Washington are states that collected state estate taxes from 2009 to 2015.

4. Inter-vivos trusts

There are times when an individual wishes to have the ability to have assets distributed from a trust before and after death. This is unlike a testamentary trust which becomes effective upon death. 

Also, you may look for confidentiality and continuity of the trust and its respective assets. Individuals seeking these factors may be excellent candidates to create an inter-vivos trust.

An inter-vivos trust is a living trust that is created during the life of the trustor (also referred to as the settlor) and allows for the distribution of assets before and after death.

There are some very good upsides to having an inter-vivos trust, including:

• Avoiding probate (unlike wills, an inter-vivos trust is not required to be probated).
• Since probate only applies to assets you own at death, assets placed in the inter-vivos trust are not subject to probate as they are owned by the trust, not the individual.
• By avoiding probate, you avoid probate costs and lengthy probate periods.
• During your lifetime, you are the trustee of the trust, which means you have complete control over assets in the trust while you are alive.
• You can change, amend and/or revoke the trust at any time while alive.
• Inter-vivos trusts are confidential and the transfer of assets from the trust is kept from the public’s view.
• There is no gap period between the time the individual dies and the appointment of an executor (as associated with wills).

Note: Inter-vivos trusts tend to have higher costs than other options regarding their formation and implementation. 

Keep in mind, though, that those costs will only be a small percentage of the amount of time and costs of probate and provide peace of mind with confidentiality and continuity.

What type of trust is appropriate for married couples?

A marital trust is not a one-size-fits-all solution. The best marital trust for you may not be the same for other couples.

It will depend on your assets, situation, expected events, and even how you and your spouse view trusts.

The benefits of getting marital trusts are good and practical if you want to secure all your assets and the people you will leave behind. However, we can’t just abruptly decide on this.

There are many technicalities in the process of getting marital trusts. One should have time, effort, and understanding before getting the right type of trust that would work for them.

If you’re unsure about it, a legal counselor could help you understand the technicalities, pros and cons of the different marital trusts.

You can also consult marital counseling therapists to see if this type of investment is good for you and your current situation.

Chelsea, the founder and CEO of the Financial Diet, discusses handling money in a relationship and figuring out where our money and relationship fears.

Final takeaway

A marital trust is indeed a wise investment. It’s an effective estate planning strategy to provide for your surviving spouse and children after your passing.

With proper planning and understanding, you can effectively quadruple the portion of your estate that won’t be subject to federal taxation by employing this tactical instrument.

That is already a substantial investment. Aside from that, by putting your assets in a marital trust, you can also ensure your fortune stays within your family.

When establishing a marital trust, there should be precautions. Make sure to work with both an estate planner and a certified public accountant, as they involve thorough tax and asset planning.

It can be a daunting task to create a marital trust. It includes many technicalities and uncertainties, but all the benefits surpass these.

The key to creating the best marital trust is to be knowledgeable, patient, work with the right people, and decide on your terms.