Couples with property, investments, life insurance and other assets can benefit from a bypass trust. In effect, a bypass trust increases the exemption amounts available in state and federal law for estate taxes. It can save an estate a considerable amount of money, and allow a couple to pass on more of their assets to their heirs.
Bypass Trusts: The Purpose
An estate that passes to a spouse is automatically exempt from taxes, but on the death of the spouse, the exemption disappears. This makes a bypass or AB trust a useful tax-planning device for a prosperous married couple. The trust splits up estate assets, passing a portion to the trust itself and another portion directly to the spouse. The amount that goes to the trust is limited to the exemption amount on estates, and is available for use by the spouse as the beneficiary. In effect, a bypass trust doubles the exemption amounts.
Two Basic Trust Types
If you set up a trust while still alive, you've created an "inter vivos" trust. A testamentary trust, by contrast, is created by the terms of a will. When you die, the testamentary trust comes into being, for the purpose of receiving assets from your estate. The trust must name a beneficiary, as well as a trustee. The trustee is responsible for handling the assets, while the beneficiary actually has access to those assets. The trustee and the beneficiary may be the same person.
Estate Tax Exemptions and Rates
Federal law sets the amount exempted from estate taxes, and allows you to pass on this amount without making any involuntary contributions to the IRS. As of 2014, the exemption had reached $5.34 million for federal estate taxes; while the estate tax rate reached 40 percent of the taxable portion. The state of Connecticut, in the same year, set $2 million as the threshold below which no estate taxes are due; the state's estate tax rates ranged from 7.2 to 12 percent. So the use of a bypass trust could allow Connecticut residents to shelter up to $14.68 million from the federal and state tax authorities.
A Simple Sample AB
Setting up a bypass trust for a married couple with $7.34 million in assets, for example, can be fairly straightforward. The husband contributes the full exemption amount of $5.34 million to the trust, naming his spouse as the trust beneficiary, and turns over the balance of $2 million to his spouse. At the husband's death -- and assuming the amounts and tax law remain the same -- the trust avoids any estate taxes. The spouse's estate will then come under the exemption amount, instead of being subject to federal and Connecticut taxes on the full estate amount of $7.34 million.
Other Useful Contributions
In Connecticut, there are several alternative destinations for money that will help you avoid estate tax. You may contribute up to $70,000 in a single year individually, and $140,000 for a couple, to a tax-advantaged 529 college savings plan, for the benefit of a child or other relative's education expenses, and pro-rate the donation over five years to avoid gift tax on gifts over $14,000. You can also pay unreimbursed medical expenses or donate to charity and enjoy a tax deduction, subject to IRS limits according to your income level.