Why use a spousal trust in estate planning?

A trust exists whenever one person (the trustee) is holding money or property on behalf of another person (the beneficiary). A spousal trust generally means that some or all of an estate is being held in trust for the use of the spouse of the deceased person. A spousal trust is usually for the entire lifetime of a spouse, but the length of the trust may vary depending on what the trust is intended to achieve.

When property or funds are held in a trust, the beneficiary doesn't own the assets, but only has use of them. For example, if there is a house in the trust, the beneficiary can live in the house but cannot sell it. When money is held in trust, the beneficiary usually receives the amount that is described in the trust, but not the full capital of the fund. Trusts are very flexible instruments, and many of the details can be tailored to the situation at hand.

There are a number of reasons that spousal trusts are used in estate planning.

Spousal trust are often used in blended family situations where the individual making a will wants to pass his or her estate to their children of a previous marriage. A woman in a second marriage might leave her home in a trust for her spouse so that he can continue to reside there if he outlives her, but he can't sell the property. The terms of the trust would say that when the spouse passes away or can no longer live in the house, it will become the property of the woman's children.

I've also seen a spousal trust used where the will was made fairly late in the testator's life, at a time when the spouse was already beginning to lose capacity. The testator was worried that someone might take financial advantage of the surviving spouse if she were left to manage a large sum of money. As a result, the funds were put into a trust instead in order to protect the spouse.

Spousal trusts can also be used to protect some assets from capital gains tax. For example, if a husband and wife own shares in their privately-owned company, and the wife passes away, her shares are subject to capital gains tax. However, the shares can be rolled over to a spousal trust so that taxes aren't payable and the business can carry on without a financial hit.

And along the tax-savings line, a spousal trust can be used where the surviving spouse already has significant income and giving him or her the estate would result in extra tax being levied. A trust is a separate tax payer and can pay tax each year on the income earned on its assets. In a case like this, you might even see the spouse named as the trustee or one of the trustees for his or her own trust.

If you are considering setting up a spousal trust in your own will, make sure you talk out the pros and cons of the idea with your estate planning lawyer. If you are considering using a trust for either of the tax reasons mentioned here, talk to your accountant before you go ahead. One sentence seen here is sufficient to point out the possiblity, but you need one-on-one advice before you take any steps.