Bypass Trusts

What is a Bypass Trust and when would I want one?

Bypass Trusts are usually created for married couples, and they’re sometimes called “A-B Trusts” or “Credit Shelter Trusts”.

Here’s how they work:

The spouses create a trust document together, and they put their assets into this jointly created trust.  By the way, we call this “funding the trust”.  While both spouses are living, they just continue living before and using assets as before.  Really, while both are alive, they can almost forget their assets are even in the trust… they just keep on living life and using their assets as they always have.

When the first spouse dies, the trust assets will be split into two new trusts.  The estate planners at Shutt Law Firm call these two newly created trusts the “bypass trust” and the “marital trust”.  The surviving spouse has access to both of these trusts for her living expenses after the death of the first spouse to die.  However, there are more restrictions on the assets in the bypass trust and less restrictions on the marital trust.

Here are 3 reasons you might want a Bypass Trust:

Blended Families

If one or both spouses have children from outside the marriage, a Bypass Trust makes a lot of sense.  Because there are some restrictions on how the surviving spouse can access the assets in the bypass trust share, this is a way to protect an inheritance for the deceased spouse’s children.  In other words, with a bypass trust, you can both guarantee that the surviving spouse will have assets available for her care during her lifetime while also guaranteeing that the children will still have something to inherit something upon the surviving spouse’s death.

Tax Minimization

Bypass Trusts can help minimize taxes.  We typically use a formula to determine how much goes into the bypass trust vs. the marital trust, and this formula is based on tax law.  The amount in the bypass trust is typically included in the first-spouse-to-die’s estate for federal estate tax purposes, while the assets in the marital trust would be includable in the surviving spouse’s taxable estate.  This is really helpful when we’re trying to maximize both spouses’ estate tax exemptions.

Asset Protection

If the spouses want to guarantee that the surviving spouse doesn’t try to give away all the couples’ assets after the first spouse dies, then a Bypass Trust could be the right answer.  The amounts in the bypass trust share can’t be gifted to others by the surviving spouse.  So, if the surviving spouse remarries, she can’t give away the bypass trust assets to her new husband.

This is also helpful to protect assets more generally.  Sometimes elderly surviving spouses are susceptible to scammers, and the bypass trust prevents the surviving spouse from getting swindled.  This is because she can’t give away the assets held by the bypass trust.

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