Bypass Trusts for Married Couples

The articles provided in this newsletter were created by Lincoln Financial Securities Corporation for the use by Don Garton.

One of the ways the federal government generates money is by collecting estate tax, which is a tax on the property you transfer upon your death. In 2007 and 2008, each person whose assets in their estate are over $2 million may be subject to estate taxes. That means the IRS may be in position to collect quite a bit of money (about $28 billion a year) from very few people each year.

If you’re married, however, there is some good news about possibly reducing/eliminating that tax. The federal government gives married couples tax-exempt property transfer credits, also known as unified or exemption credits. A bypass trust is a very powerful tool for spouses who want to reduce/eliminate an estate tax because the trust maximizes those credits and helps reduce taxes when assets are passed to the next generation.

The federal government sets ceilings on the amount of assets exempt from the estate tax ($2 million through 2008) and taxes the value of an estate that exceeds that amount (the rate in 2007-2008 is 47%). But by doing proper planning and setting up a bypass trust, you may be able to shield some of your assets from federal estate tax and possibly also increase the value of the assets you’re passing to your heirs

How a Bypass Trust Works

“Without a bypass trust, sometimes referred to as a credit shelter trust or an exemption equivalent trust, assets owned by the first spouse transfer upon death to the surviving spouse tax-free,” says Ferriera. But that may simply increase the surviving spouse’s estate when there is only one exemption, which could trigger an unnecessary estate tax. If assets are passed to a bypass trust, however, no estate tax would be owed on assets of $2 million or less.

A bypass trust is typically created in a living trust or a will, and the assets are then managed within the trust. After the bypass trust has been funded, the balance of the estate is usually transferred to the surviving spouse who is a U.S. citizen either outright, or put into a Qualified Terminable Interest Property (QTIP) trust to take advantage of the unlimited marital deduction, which pays income to the surviving spouse during that individual’s lifetime; the remainder typically will pass to children when the surviving spouse dies.

When the second spouse dies, assets in the bypass trust can be transferred to whomever the first spouse decided would be the ultimate beneficiary when the trust was created. Most people name their spouse the primary beneficiary and their children the secondary beneficiaries.

Funding and Accessing the Trust

There is some strategy involved with funding the trust. Low-income, high-growth investments are best because no matter how much the assets in the trust have grown, there’s no estate tax on the trust when it passes to the next generation, he says.

Ideal assets for a bypass trust include equities, exercised stock options, land that has high growth potential and rental property.

If you have assets in a qualified retirement savings plan, such as a 401(k), consult with an accountant and your financial planner before changing the title of those assets or listing a bypass trust as a beneficiary of those assets to avoid paying unnecessary or accelerated income tax. And, since different states have different laws about property ownership and titles, you should create the trust using an estate planning attorney who’s licensed in the state in which you live.

In most cases, the standard bypass trust gives the surviving spouse the right to income from the trust as well as the ability to change how the assets are invested to increase or decrease the amount of annual income that the trust generates.

The trust often also gives the surviving spouse the right to use the principal to pay for health, education and maintenance costs, as well as to maintain the spouse’s standard of living, he says

Selecting the Right Trustees

Trustees are determined when the trust or will creates the bypass trust, and most spouses name each other the primary trustees of their bypass trust. However, you may want to name a co-trustee, such as an adult child who is savvy with money to have some continuity—particularly since the original document might have been written years ago.

A good document will state that as much money as is allowed tax-free that year should be put into the bypass trust. That way you don’t have to update your document every year if the exemption amount changes.

You should consider a bypass trust if you are interested in inheritance protection, management continuity and tax reduction.

 

Any discussion pertaining to taxes in this communication (including attachments) may be part of a promotion or marketing effort. As provided for in government regulations, advice(if any) related to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor.