Bypass Trust Helps Avoid Certain Estate Planning Issues

by | Jan 19, 2022 | couples' estate planning, estate and tax planning, Estate Planning, estate planning documents

There are at least four explanations for the recent interest in protecting couples’ assets from estate taxation, James Blase, CPA, JD, LLM points out in Financial Advisor Magazine:

  • the rise in the stock market
  • the “portabililty election”
  • the SECURE Act of 2000
  • the expectation that the federal estate tax exemption is scheduled to be reduced by half

As we work with our Geyer Law estate planning clients, one important goal is to minimize taxes:

  • in the estate of the first of a couple to die
  • in the estate of the second of the couple to die
  • for the next generation

Blasé points out the big advantage of the portability election passed into law in 2013: portability allows a surviving spouse to use any unused portion of the federal estate tax on the first spouse’s estate in addition to his or her own estate tax exemption.

While it might appear that there is no need to consider a bypass trust in the estate plan, there are actually several very important reasons to do just that:

  1. When the second spouse dies, the portability election will not remove appreciation in value that has taken place since the first spouse’s death; a bypass trust will remove all appreciation.
  2. If the surviving spouse remarries and the new spouse predeceases him or her, the portability election will not apply to the appreciation of assets. In contrast, remarriage will not be relevant in the case of assets transferred to a bypass trust.
  3. The “ported” assets can be subject to potential lawsuits against the surviving spouse and even to potential claims of a new spouse; lawsuits and claims are avoided with a bypass trust.
    With a portability election, the first spouse to die loses the ability to control where the assets go to upon the survivor’s death; a bypass trust allows such control.

IRA and 401K assets

There are special planning challenges when it comes to assets in retirement plans such as IRAs and 401Ks. Adult beneficiaries must now empty the accounts within ten years, paying tax on each withdrawal, as we pointed out in “Who Wants to Be an IRA Beneficiary?” (exceptions to this rule include spouses, minor children, disabled or chronically ill heirs, and beneficiaries not more than 10 years younger than the participant, who may choose to spread inherited IRA withdrawals over their remaining actuarial life expectancies).

The whole concept of using bypass trusts for IRA and 401K money is now called into question
because under the SECURE Act, there is no more “stretch”. What’s more, Blasé points out, the children will likely be in their highest income tax brackets when the surviving spouse passes, and now they would have to add the IRA or 401(k) plan proceeds to their peak taxable incomes over a maximum period of 10 years.

No simple answer, the author concludes. “The after-tax math will be different in each estate planning situation, the author concludes. At Geyer Law, we agree…

– by Rebecca W. Geyer