For years, bypass trusts were a practical way for people to avoid an excessive estate tax burden. Yet, changes to the tax in recent years may make you reconsider whether this type of trust is still necessary to protect your wealth. Since the current exemptions are much higher than before, many people who once needed bypass trusts no longer do. But if your estate’s value exceeds these, you will want to understand when and how bypass trusts work.
How bypass trusts work
Bypass trusts – also called AB trusts – in fact consist of two different trusts. The A trust is a revocable living trust. Both you and your spouse will hold your assets in this trust during your lifetimes. If you pass before your spouse, your assets will transfer to the B trust, which is irrevocable. Since this trust is a separate entity from you, you no longer own the property in it, and it is not part of your estate. Because of this, the B trust will not face estate taxes.
While you can name your spouse as trustee of the B trust, they cannot use its assets for personal gain. But they can derive income from it to pay for basic expenses. One your spouse passes, their share of assets will transfer from the A trust to the B trust. Any beneficiaries you have will receive these, then, without facing taxation.
When bypass trusts make sense
A bypass trust may make sense if your estate’s value exceeds federal or state exemptions. If your estate is worth $11.58 million or less, it will not face federal estate taxes. This amount increases to $23.16 for married couples. Yet, Connecticut is one of 12 states that adds a state estate tax on top of the federal estate tax. For individual estates, this amount is $5.1 million. The state’s exemption, though, will increase to match the federal exemption by 2023.
Creating a bypass trust can be a useful way of protecting your wealth if your estate will face taxation down the road. An attorney with estate planning experience can help you evaluate if it makes sense in your circumstances.