Bypass trusts allow spouses to split their estates for tax purposes, thereby avoiding potentially high federal tax rates. The most effective trusts are those that include as many of a couple's assets as possible, but this does not mean the couple does not need a will. Wills can pass ownership of property not held by the trust, along with accomplishing other purposes a trust cannot.
How Bypass Trusts Work
Bypass trusts, sometimes called A-B trusts, are those structured to split the couple's assets when one spouse dies, placing each half in a separate trust. One trust holds the half that belonged to the deceased spouse, while the other half goes to a trust held by the surviving spouse. Assuming the trust document is up-to-date and the assets are titled properly, most of the couple's assets can be distributed this way outside of a will. While the surviving spouse is still alive, he has the use and benefit of the assets in both trusts, and upon his death, the assets in both trusts go to the designated trust beneficiaries.
Benefits of Bypass Trusts
Because the assets are split when the first spouse dies, lowering the value of each spouse's estate, the couple may avoid certain federal or state estate taxes. For example, if the estate tax threshold is $5 million and each spouse's trust held $3 million, the couple avoids paying hefty estate taxes on the $1 million by which they would have exceeded the estate tax threshold without an A-B trust. Tax rates and rules change regularly, so it may be best to consult with a lawyer if you aren't sure whether such a trust is right for you.
Wills Distribute Additional Assets
Typically, trust documents do not distribute everything the spouses own, and a will is needed to ensure the remaining assets are distributed according to the deceased spouse's wishes. For example, personal property and family heirlooms may need special direction. A will, sometimes called a pour-over will when a trust also exists, can ensure that smaller or unique assets are appropriately distributed. The will can put all of those assets into the trust or it can give certain assets to a named beneficiary, such as a family heirloom to a particular child. Without a will, state law controls who inherits assets not held in the trusts.
Wills Have Other Purposes
Bypass trusts are designed primarily to avoid estate taxes, so they may not be effective to accomplish other estate-planning tasks. For example, trust documents do not name an executor to take care of the administration of the deceased's estate. Wills can also name a guardian for the deceased's minor children, a topic inappropriate for trust documents. Thus, a will is an important part of an overall estate plan, even one that has a bypass trust to distribute most of the couple's assets.