Is a Bypass Trust Necessary?

The recent surge in stock market values, combined with the SECURE Act’s passage and the impending reduction in federal estate tax exemption, has sparked renewed interest in estate planning strategies for retirement accounts held by married couples.

What Is a Bypass Trust?

A bypass trust removes designated portions of IRA or 401(k) proceeds from a surviving spouse’s taxable estate while delivering multiple tax advantages.

Why Consider a Bypass Trust?

While portability – enacted in 2013 – permits surviving spouses to access unused federal estate tax exemptions from their deceased spouse, this approach has limitations:

• Appreciation protection: Portability doesn’t shield appreciation gains from the surviving spouse’s taxable estate; a bypass trust removes all appreciation.
• Remarriage concerns: The portability election becomes void if the surviving spouse remarries and the new spouse dies first. Bypass trust protections remain unaffected.
• Generation-skipping tax: Portability doesn’t cover federal generation-skipping transfer taxes, which could burden heirs’ estates.
• Creditor protection: Ported assets lack the liability shield that bypass trusts provide against claims and lawsuits.
• Estate distribution control: The first deceased spouse cannot direct where ported assets ultimately go – critical for blended families seeking to secure children’s inheritances.

Important Considerations

Bypass trusts face distinct challenges. They become subject to the highest federal income tax rates at modest income thresholds (approximately $13,550), and they forfeit the income tax basis step-up available to surviving spouses.

However, strategic planning using IRC Section 678 can mitigate these burdens by eliminating elevated trust taxation rates. Additionally, including a conditional general testamentary power of appointment may enable partial or complete income tax basis step-up when the surviving spouse passes.

The Bottom Line

Every situation demands individualized analysis. The right choice depends on retirement account size, the surviving spouse’s tax circumstances, and heirs’ tax positions. Consulting an experienced estate planning attorney ensures families select strategies genuinely aligned with their objectives and financial realities.

If you or a loved one needs assistance with trust planning or estate planning, do not hesitate to contact The Stegall Law Firm. We are here to help.