A bypass trust removes a designated portion of an IRA or 401(k) proceeds from the surviving spouse’s taxable estate, while also achieving several tax benefits, according to a recent article titled “New Purposes for ‘Bypass’ Trusts in Estate Planning” from Financial Advisor.
Portability became law in 2013, when Congress permanently passed the portability election for assets passing outright to the surviving spouse when the first spouse dies. This allows the survivor to benefit from the unused federal estate tax exemption of the deceased spouse, thereby claiming two estate tax exemptions. Why would a couple need a bypass trust in their estate plan?
This strategy should be reviewed in light of the SECURE Act 10-year maximum payout rule, since the outright payment of IRA and 401(k) plan proceeds to a surviving spouse is entitled to spousal rollover treatment and generally a greater income tax deferral.
Bypass trusts are also subject to the highest federal income tax rate at levels of gross income of as low as $13,550, and they do not qualify for income tax basis step-up at the death of the surviving spouse.
However, the use of IRC Section 678 in creating the bypass trust can eliminate the high trust income tax rates and the minimum exemption, also under Section 678, so the trust is not taxed the way a surviving spouse would be. There is also the potential to include a conditional general testamentary power of appointment in the trust, which can sometimes result in income tax basis step-up for all or a portion of the appreciated assets in the trust upon the death of the surviving spouse.
Every estate planning situation is unique, and these decisions should only be made after consideration of the size of the IRA or 401(k) plan, the tax situation of the surviving spouse and the tax situation of the heirs. An experienced estate planning attorney is needed to review each situation to determine whether or not a bypass trust is the best option for the couple and the family.
Reference: Financial Advisor (Feb. 1, 2022) “New Purposes for ‘Bypass’ Trusts in Estate Planning”
Suggested Key Terms: Bypass Trust, Estate Planning Attorney, IRA, 401(k), Surviving Spouse, Testamentary Power of Appointment, Income Tax, Basis Step-Up, Appreciated Assets, Beneficiaries, Heirs, Portability Election, SECURE Act, Exemption