Reasons for a Sub-Trust

A sub-trust is a trust within a trust. Typically, sub-trusts come into being upon the happening of an event. Usually, one single trust exists during the lifetime of both spouses, and various sub-trusts come into existence after the death of one spouse. There are a variety of sub-trusts, and the rules around them are complicated. These sub-trusts have many different names, including, for example, a Bypass Trust, a Residual Trust, a Family Trust, a Tax Avoidance Trust, and an A/B Trust.

If you are considering adding sub-trusts into your estate plan, it is critical to work with an experienced Phoenix estate planning attorney. Below are five reasons why you would want to use a sub-trust in your Phoenix estate plan.

1. A sub-trust can protect trust assets from creditors. If you want to protect trust assets from creditors, you can create an irrevocable sub-trust. This may be a priority if a beneficiary is in financial difficulty or the owner of their own business. Additionally, a sub-trust can protect the trust assets from property division during a divorce. If the property is distributed directly to the beneficiary, it can inadvertently become marital property subject to division by the court.
2. A sub-trust can provide tax advantages. One reason to use a sub-trust is to limit federal estate taxes for wealthy individuals. The 2021 federal estate tax exemption is $11.7 million for an individual and $23.4 million for a couple. If your estate exceeds this amount, you can limit federal estate taxes by dividing the trust into two sub-trusts, sometimes referred to as an A/B Trust or Bypass Trust. The A Trust is funded with property with a value lower than the federal estate tax limit and is for the use of the spouse tax-free under the unlimited marital estate tax deduction. The B Trust is irrevocable and not subject to the federal estate tax, even if the trust increases in value. Upon the surviving spouse’s death, the B Trust is not included in the surviving spouse’s estate because they did not have control over the property. A sub-trust can provide family income tax savings when the trust generates significant income each year, and the beneficiaries have incomes or other income-generating assets.
3. A sub-trust can protect assets from spend-down requirements for beneficiaries. Some government programs, such as Medicaid, severely limit the number of assets and income that a person receiving benefits can have. If an individual receiving these benefits receives trust property directly, it can have the effect of disqualifying them if they do not immediately spend down their inheritance. However, you can design a sub-trust to supplement government benefits without risking ineligibility. Typically, the government does not treat property in an irrevocable sub-trust as property belonging to the beneficiary, and therefore, it will not affect eligibility.

5. A sub-trust can protect trust assets for children from a first marriage. Blended families are becoming more and more common. In a standard estate plan, a spouse leaves their property to their surviving spouse. After the surviving spouse dies, the property passes down to the children. Problems arise when you have children outside of your marriage, and you want to guarantee they are taken care of. Creating an irrevocable sub-trust can solve this issue. You can leave property to your spouse while at the same time make an irrevocable sub-trust for your children outside your marriage that your spouse will not have control over.
6. A sub-trust can protect trust assets for individuals incapable of managing their finances. You can use a sub-trust in situations where you want to restrict the power of a beneficiary who is unable to manage their trust property properly. As part of the sub-trust, you can designate a third party to be the trustee and manage the trust property on behalf of the beneficiary. Additionally, you can place restrictions on how the trust property can be distributed for the benefit of the beneficiary (e.g., education, travel, or purchasing a home). You may want to consider this option if you have a beneficiary who is a minor, disabled, dependent on drugs or alcohol, or financially irresponsible.

Your Phoenix Estate Planning Attorney

If you have questions about sub-trusts, you should contact Nicole Pavlik Law Firm. There are various reasons why you want to include a sub-trust in your estate plan. A Phoenix estate planning attorney can help you decide what is best for you and your family. Call Nicole Pavlik Law Firm today at 602-635-6176 for a free consultation.