When Might a Bypass Trust Be Better than Portability?

Bypass Trust
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Married couples can utilize a bypass trust to provide more estate planning control.

Both married and single people must face the challenges of life.

They must go to work, pay bills, and navigate the deaths and illnesses of loved ones.

Eventually, they must face their own deaths.

It is best to have an estate plan prepared prior to this final event of life, let alone preparing for potential incapacity.

According to a recent Financial Advisor article titled “Estate Planning for Married Couples’ IRAs And 401(k)s,” married couples have more options for estate planning.

A bypass trust can be beneficial for married couples.
Those who are married may elect to rely on a bypass trust rather than portability.

In some ways, federal estate laws can favor those who are married.

One example is the “portability election.”

What is the portability election?

This estate tax planning alternative method became law in 2013 and allows the unused federal estate tax exemption of the spouse who has died to be used by the surviving spouse.

Essentially, the surviving spouse can utilize two tax exemptions.

Although this can certainly help married couples with large 401(k) and IRA accounts, it does not account for the appreciated value of these assets.

This is where a bypass trust would be beneficial.

What does a bypass trust accomplish?

A bypass trust removes a the appreciation of the 401(k) and IRA assets from the taxable estate of the surviving spouse.

In addition to removing asset appreciation of these accounts from the taxable estate, a bypass trust can also protect those in situations where portability is not applicable.

When might this happen?

Portability is forfeited when the surviving spouse remarries and then outlives this next spouse.

A bypass trust does not become ineffective in these circumstances.

Another area where the portability election is not applicable is the federal generation-skipping transfer tax.

What does this mean?

The heirs could be subject to a federal transfer tax upon their deaths.

Additionally, the portability election does not shield the inherited assets from lawsuits against the surviving spouse.

If the spouse remarries, the new spouse may also make claims on the assets.

Consequently, a bypass trust is the preferred approach when “remarriage protection” is a primary objective.

A bypass trust can protect these assets from lawsuits or divorce agreements.

The first spouse to die will have no control over what happens to the assets if a portability election is used rather than a bypass trust.

With a bypass trust, the deceased spouse will have been able to provide directions for the use and distribution of the assets.

When using bypass trusts, choices can be made to reduce the taxable estate for the children of the married couple and to divide assets between the trust and an outright inheritance to the spouse.

Working with an experienced estate planning attorney can help you determine whether a bypass trust is best for you and your family.

As with much of life, there is no one-size-fits-all solution.

Reference: Financial Advisor (Jan. 7, 2022) “Estate Planning for Married Couples’ IRAs And 401(k)s”

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