bypass trust Archives - Ask Liz Weston

Dear Liz: You mentioned in a recent column that people should check estate plans created before 2010 because they might contain bypass trusts that are no longer needed. The classic AB Trust, although not necessary now for the estate tax exemption for most people, still can be useful if one spouse wants to ensure her half of the estate goes as she desires if she is the first to die.

Answer: Possibly, but people should make the decision proactively by having their estate plan reviewed and discussing their options with an experienced attorney, since these trusts have some significant disadvantages.

Bypass, or AB, trusts were a routine part of estate planning even for middle-income couples when the estate tax exemption limit was just $675,000. When the first spouse died, a portion of the couple’s assets went into an irrevocable trust that would avoid estate taxes when the surviving spouse died. Because the trust was irrevocable, the surviving spouse couldn’t change its terms and had limited access to the assets.

Also, assets in the irrevocable trust don’t get a step up in tax basis when the survivor dies. That means the ultimate beneficiaries could wind up paying higher capital gains rates when they sell the assets. When the estate tax exemption limit was low, couples were gambling that the estate tax savings would outweigh the future capital gains cost.

Today, far fewer families have to worry about estate taxes. The exemption limit for 2022 is over $12 million per person and over $24 million per couple. Even after the current limit sunsets in 2025, individuals would be able to exempt over $6 million and couples over $12 million from estate taxes. Estate tax exemptions are also now “portable,” which accomplishes much of what the AB trust was designed to do in ensuring the exemption of the first to die wasn’t “wasted.” Now the amount of the exemption limit that isn’t used by the first spouse to die can be transferred to the survivor’s estate.

Bypass trusts are still routinely used for wealthier people and those who live in states with low estate tax exemption limits, but for many people this estate planning tool has outlived its usefulness.

Dear Liz: We married late in life and each of us brought separate property to the marriage. One spouse has four children and the other none. We have a marital trust that allows for the spouse upon death to receive the entire estate. Upon the death of both spouses, how would you draft a provision that would allow the remainder of one spouse’s separate property to be allocated to her children and the other spouse’s separate property to be donated to a charitable foundation?

Answer: Instead of allowing each other to inherit everything outright, you might want to consider a bypass trust. These trusts allow the surviving spouse to benefit from the assets during his or her lifetime. Upon the surviving spouse’s death, the assets are bequeathed to the ultimate beneficiaries. The survivor can’t alter the trust to change or prevent that.

Bypass trusts can create family tension, however. If the mother in your example were the first to die, her children would have to wait for “their money” until her spouse died. In the case of much younger or unusually healthy spouses, that can be a long wait, with the kids worrying that the surviving spouse will spend most or all of the money in the meantime.

If that could be an issue in your case, you might consider buying life insurance on the mother, Los Angeles estate planning attorney Burton Mitchell said.

“Some people fund for the children with life insurance on that parent’s life, so that the children don’t have to wait for the second death,” Mitchell said, “and to minimize tension with the children with the surviving spouse.”

You also should consider having a meeting with the children once you’ve decided how to handle this, Mitchell said.

“It is often better for them to understand what is happening and let them ask questions to their parent, before they discover the facts after the funeral,” he said. “At that point, someone is already dead and the survivor’s answers are suspect.”

If your estate is greater than estate tax exemption limits — currently $5.12 million, but scheduled to drop to $1 million in 2013 — you may want to take additional steps to reduce the future tax bite. One option is known as a qualified terminable interest property or QTIP trust. Your estate planning attorney can provide you with details. And yes, you should have an attorney, particularly if you have a large estate or someone may contest the will.

“Anyone can download documents off the Internet or go to a forms service or mill, but to do it right and to minimize problems later, you have to understand each individual’s situation and craft a plan that works best for them,” Burton said. “It’s like snowflakes — estate plans may look similar, but no two should be identical.”

Q&A: Bypass the bypass trust

Bypass trust can get money to the right heirs, eventually

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