Not every trust fits every situation. The interests of older folks are usually different than those of younger generations. And couples with adult children often have different concerns than those with little ones and college years still ahead. That’s why it’s always good to revisit your estate plan and make sure it still fits your circumstances. As time goes on, your family situation may shift along with tax laws that could affect your choices on how best to plan for your estate. If you created a plan when the tax thresholds were relatively low ($1 million) then it may be time to take a second look.
The Tax Cuts and Jobs Act signed into law by President Donald Trump in December 2017, made significant changes to the Tax Code by greatly increasing the amount a person can give tax free. As of 2020, the estate tax limit is now $11.58 million per individual; up from $11.4 million in 2019. And with existing “portability” laws, a deceased spouse’s unused exemption amount can be added to the survivor’s exemption so married couples can transfer a combined estate tax exclusion of over $23 million! Now, with the current high estate tax threshold, the bypass trust model may be work like an outdated phone: still functional but not necessarily the best option.
A Closer Look at the Bypass Trust
Most married couples want the surviving spouse to be able to have access to the couple’s full wealth for their support during widowhood. Depending on personal circumstances this may, or may not, be a good idea. In any event, before estate tax increases in recent years, the best way for a married couple to continue to provide for the surviving spouse and avoid estate taxes at the first death was to create a bypass trust. Bypass trusts are funded with as much of the deceased spouse’s property that can pass tax-free using his or her exclusion which, nowadays, is typically the entire share of decedent spouse’s community property. Bypass trusts benefit the survivor during life but “bypass” the survivor’s estate at death with any remaining amount going to named beneficiaries.
If your trust was created to bypass estate taxes and your estate is now well below the current threshold, then the main purpose of your bypass trust is lost. The high estate tax exclusion makes the bypass trust unnecessary in most instances because most people don’t have estates large enough to qualify for payment of estate taxes in the first place. The need to divide assets at the first death and associated costs with administering separate trusts for the surviving spouse’s lifetime, including the preparation of a separate income tax returns for beneficiaries, is more costly than leaving all assets to a spouse and relying on portability to use both spouses’ exclusion. And assets in a bypass trust may be taxed at compressed trust income tax brackets which subject any undistributed income over a certain amount to be subject to the top marginal income tax rate.
These trusts are still relevant to protect the intentions of the first spouse to die and provide some creditor protection for the survivor so all is not lost. But if these protections don’t interest you, consider that bypass trusts require more significant administration. Many married couples will keep their existing bypass trust even if they don’t need it for tax purposes because it still provides some desired benefits, but there are better options out there. Others simply don’t want the hassle and expense of a bypass trust if there is no real threat of estate taxes, which is usually the case.
What to Do?
We recommend that you review your estate plan with your attorney every five years or after any major life changing event. Even if the potential benefits associated with losing the bypass trust don’t spur you to take action today, think about reviewing your options next time you update your estate plan. You can take advantage of a similar structure without losing income tax-basis step up at the death of the surviving spouse. Call today and learn more about updating your current plan! (714) 619-4145
Disclaimer: This article is not intended to provide tax advice. You must consult your accountant or other tax advisor for any specific income tax guidance.