Using Disclaimers as an Estate Planning Tool

My husband tells me that to do any job right, you need the right tools. He practices what he preaches because we have a garage full of tools for any job you can imagine. (He and Tim “The Tool Man” Taylor have a lot in common.) The problem is, I can stand in our garage and know that the right tool is there – somewhere—to help me do whatever project may need to be done, but I have no idea which tool to use.

The same can apply to estate planning. There are many tools in the estate planning toolbox, and your team at Greenleaf Trust is committed to helping our clients and prospective clients understand the tools that may be appropriate for each family’s situation to meet their goals.

One estate planning tool that sometimes is not at the forefront is the use of disclaimers, somewhat equivalent to the “Sawzall” tool on the shelf in our garage that does many things. Disclaimers can be used in various situations to add flexibility to an estate plan, or to fix a problem after the property owner has passed away.

Pre-death planning with disclaimers can be an effective technique to allow for unknown future circumstances. The property owner can plan ahead, with language built in to his or her documents that can accommodate most situations, including residuary clauses that provide for disclaimers (“takers in default”) should a spouse or other beneficiary decide to take advantage of a disclaimer. The disclaiming beneficiary cannot direct where the assets go, so the asset owner can plan in advance for this possibility. I like to say that good estate planning attorneys consider all of the “what ifs” with their clients. In the case of disclaimers, attorneys will routinely discuss opportunities for disclaimers with asset owners to create the ability for the named beneficiary to move assets to the next-in-line beneficiaries who might need the wealth more than the originally-named beneficiary.

Disclaimers can also be useful for post-mortem planning when more facts are known, or if unintended consequences occur in a decedent’s estate.

Stated simply, in the world of estate planning a disclaimer is the refusal to take a gift or bequest. Congress has added some rules that cause a disclaimer to be considered a “qualified disclaimer” for federal transfer tax purposes. Here are the basic guidelines for a qualified disclaimer:

A disclaimer is irrevocable and must be made in writing.
The disclaimer must be made within nine months from the time the person had the right to receive the asset. (There is an exception for those under 21 years of age at the time they had that right: they may disclaim until nine months after their 21st birthday.)
The person disclaiming cannot accept an interest or receive any benefit from the asset being disclaimed.
The person disclaiming may not control or direct the disclaimed asset’s disposition in any way and the property must pass either to the decedent’s spouse, or to a person other than the person making the disclaimer.
If all of these conditions are met, the disclaimed interest passes as if the named beneficiary had never received the property. The next beneficiary (or beneficiaries) step into the shoes of the disclaiming beneficiary. Unless specifically named by the property owner, state law determines the next beneficiaries.
Other points of note:
A beneficiary can make a partial disclaimer for a portion of the property he or she is slated to inherit.
A qualified disclaimer of assets is not considered for gift, estate or generation skipping transfer tax purposes according to federal transfer tax law.
There is a special opportunity for a spouse (and only a spouse) to disclaim assets. A spouse could disclaim assets, with the assets then passing to a trust where the disclaiming spouse continues as a trust beneficiary. The disclaiming spouse cannot, however, have control of the assets, or have a power of appointment over the trust.
There are myriad situations where disclaimers could and should be considered. Just to illustrate the potential power of disclaimers, following are just three simplified examples of when it might make sense for a beneficiary to disclaim.

Example #1 – Potential Changes to the Lifetime Gift/Estate Tax Exemption and Lack of Predictability

The current lifetime exemption for gift and estate tax is approximately $12,000,000 for a person who dies this year. However, unless Congress acts, that exemption amount (that now increases annually for inflation) is slated to sunset and return to approximately $6,000,000 in 2026. Congress may act and change the law either before or after the sunset date.

In addition, legally married U.S citizen spouses can share the unused exemption when the first spouse dies if an estate tax return is filed within two years of the first spouse’s death. (At this time, this shared unused exemption rule does not sunset in 2026).

The point is, it is difficult to know what the exemption amount will be, not only when a first spouse dies, but thereafter when the second spouse dies.

For example, a married couple has a combined estate worth $15,000,000 with assets held in one spouse’s revocable trust that passes to the surviving spouse, and then to the children at the surviving spouse’s death. The spouse with the trust assets dies in 2022 having made no taxable gifts during his or her lifetime. The deceased spouse’s remaining unused exemption of approximately $3,000,000 can be added to the surviving spouse’s lifetime exemption if an estate tax return is timely filed. The surviving spouse has few assets of his or her own, but also does not need $15,000,000 for living expenses throughout his or her lifetime, and would like the children to benefit sooner rather than later at his or her passing.

As long as all of the requirements are met for a qualified disclaimer, the surviving spouse can disclaim a portion of the trust assets not needed for living expenses, let’s say $6,000,000 in this example, which allows the children to receive those assets at the time of the disclaimer per the terms of the trust, without any gift tax consequences to the surviving spouse.

In our example, the surviving spouse passes away in 2026, when his or her exemption is $6,000,000 (if the law is not changed), plus the deceased spouse’s unused exemption of $3,000,000, for a total of $9,000,000. The value of the surviving spouse’s estate (if we consider no growth in assets since 2022) is $9,000,000, and no estate tax is due.

In this case, if the surviving spouse had retained all of the assets and disclaimed none, the estate tax due at death would be approximately $2,100,000. Not only do the children receiving the disclaimed assets have use of those assets sooner, saving $2,100,000 in estate tax by doing a qualified disclaimer is quite a good deal!

Example #2 – Keeping Things Equal

Another example of potential use of a disclaimer is dealing with a situation we see too often, in my opinion. Without understanding the consequences, during their lifetimes, parents who own a bank account add one of their children as a co-owner of the account to facilitate bill payment.

The parents’ overall goal is to leave their assets equally to their children, as stated in their wills and/or trusts. By adding one of their children to their bank account they have just created several issues: inequality of inheritance to their children, potential gift tax consequences, and risk of losing their bank account assets to their co-owner child’s creditors.

In this example, when the second-to-die of the parents passes away, the bank account passes outright to the child who is the surviving owner. Nothing from the bank account will pass to the other children, potentially straining the relationship between the siblings, especially if the bank account has a sizable balance.

The child who inherits the property could disclaim the bank account. As long as the parents’ wills or trusts provide for all of their children to receive assets equally, the bank account proceeds could then be divided and pass equally to all of the children via the disclaimer. Of note, this would be considered a non-qualified disclaimer because the disclaimant had an interest in the assets. This disclaimer would be considered a gift from the child who inherited the account to his or her siblings. However, if the gift to each of the siblings is less than the annual exclusion amount ($16,000 for gifts to any one individual in 2022), no gift tax would be incurred by the child making the gift. Making this disclaimer might be worth it to keep peace in the family, whether or not it is a reportable gift for gift tax purposes.

Totally separate from the issue of inequality of inheritance issue described above, when the parents added the child as co-owner of the bank account, 1/3 share of the balance at the time the child was added is considered a gift (hopefully less than the annual exclusion amount), and it also exposed the parents’ bank account to any creditor claims for their co-owner child (think divorce, bankruptcy, lawsuit claims). There are much better and safer ways to handle this situation, including the use of a Durable Financial Power of Attorney naming the child as agent, adding a child as an “authorized signer” on the account, or, for our clients, Greenleaf Trust can assist with bill payment services when needed.

Example #3 – Trust as Beneficiary of an IRA

Naming a trust as a Traditional IRA beneficiary is complicated, and cannot be changed once the IRA account owner has passed away. It can also be very expensive when you consider that an irrevocable trust is taxed at the highest marginal federal income tax bracket of 37% when the trust’s income, which includes required Traditional IRA distributions to the trust, exceeds about $13,300 during the year. If the surviving spouse and children are named as current beneficiaries of the trust, the trust may be taxed at a much higher rate than if the spouse or children had been named individually.

In addition, if the beneficiary designation has not been updated in many years, the original purpose of naming the trust may no longer apply, such as providing for minor children who are now adults. Also, the SECURE Act of 2019 and the ongoing interpretations of the new rules by the IRS are creating sometimes confusing and very complex situations when a trust is named as beneficiary of an IRA.

If there is appropriate disclaimer language in the trust, the spouse and children could disclaim the IRA portion of the trust. Individual inherited IRAs could then be established for each of them, and required distributions would be taxed at their respective marginal income tax brackets. The SECURE Act rules for individual beneficiaries are still complicated, but clearer than when a trust is named.

There are risks and cautions when considering a disclaimer of property.

State tax laws vary, so it is important to consider local laws in addition to federal tax law prior to making a disclaimer.

Before making a disclaimer (qualified or not), make sure to understand who will be the recipient of the disclaimed property. If specific “contingent” beneficiaries are not named, state law will dictate the ultimate beneficiaries. In Michigan, there is a “Table of Consanguinity” that provides this direction.

Often the reason for disclaiming property is related to tax savings. Tax savings will not occur at the federal level unless all four requirements for a qualified disclaimer are met, including the requirement that a non-spouse disclaimant may not receive the disclaimed property in any way. Sometimes there are contingencies built into IRA agreements, wills, and trusts that may cause the disclaimed asset to eventually pass to a non-spouse disclaiming beneficiary that will negate the tax savings. It is important to review all aspects of the property owner’s documents to assure there are no issues if tax savings is the goal.

Timing and lack of control over the disclaimed property are important considerations for qualified disclaimers. The election to disclaim is irrevocable, and we recommend using the services of a good estate planning attorney when considering this option.

Please keep this flexible and useful estate planning tool in mind when updating your estate plan documents with your attorney. If you have a specific situation where you feel a disclaimer might be useful, please let your client centric team know and we will be happy to discuss it further with you.