Using the Marriage Deduction

There may be times when leaving a large amount of money or property to your spouse tax-free is not the best answer for estate tax concerns. Although it may eliminate the tax for the first of a married couple to die (assuming that the size of either estate is below the tax threshold), a financial problem can occur at the death of the second spouse. A widow or widower who's inherited a lot of money may now have a very large estate, and when he or she dies there's no longer a marital deduction to take care of the estate tax bill.

In contrast, if each of the couple were to use their personal estate tax exemption when they leave the property, none of it would be subject to tax. Both husband and wife's share would be under the estate tax threshold.

Generally speaking, if both spouses are older, leaving property outright from one to the other usually either creates a taxable estate where one needn't have been, or greatly increases the tax on the surviving spouse's estate. A more advantageous method to leave property for the use of a surviving spouse and still minimize overall estate tax is to use an AB trust.

Using the marriage deduction to avoid estate tax generally only makes sense if one of the couple is young enough to reasonably expect to survive for a number of years after the first spouse dies. Considering that a large number of marriages are between spouses where one is at least ten years older than the other, and the fact that on average women outlive men by about five years, this can be a quite common occurrence.

Leaving property directly by the marriage deduction certainly does offer the advantage of simplicity. And assuming that the surviving spouse lives for more than a few years, he or she has plenty of time to avoid the possibility of eventual estate taxes by spending some of the money or making tax-free gifts using the $12,000 annual gift tax exclusion allowed by the IRS.

Is there an age where you might be too old to rely on the marital deduction to handle your estate tax situation? Of course, there are no hard and fast rules; as a very rough guideline, however, 65 to 70 years of age seems to be a reasonable dividing line. But it depends much more on you, your health, and your level of comfort with your current plans.

If both you and your spouse are young and your statistical chances of dying are still small, you might consider foregoing any exotic estate planning instruments for the time being and just leave your property to each other by way of the marriage deduction. Then, if one of you does die prematurely, the survivor will likely have many years to spend the money that's inherited, thereby reducing the estate. Again, there's no particular age at which estate tax planning suddenly becomes essential; it depends upon how comfortable you feel with waiting.

Additionally, if one spouse is considerably younger than the other, the older spouse may want to utilize the marital deduction to avoid estate tax. Again, the rationale is that the younger spouse will be the survivor, and will have plenty of time to either spend the inherited money or come up with some other way to reduce the estate tax that may be due at his or her death.