Okay, I know.... "Scott, you have been talking about the fact that the estate tax has been repealed. Why should I care about saving on taxes that don't exist?" Fair question. Although estate taxes were repealed in 2010, they come back with a vengeance on January 1, 2011. Unless Congress acts soon, we will revert back to the way the law was prior to 2001 -- a relatively small $1,000,000 individual exemption from estate tax and a 55% rate! Pique your interest? Read more to see how married couples can DOUBLE the amount they can pass to their children or other beneficiaries ESTATE TAX FREE!
If a married couple has combined assets of more than $2,000,000, they should really consider creating a bypass (or credit shelter) trust. At first blush, you may be thinking, “$2,000,000? We are not even close.” But think again. We are talking about a couples’ “gross estate” here. That basically means everything you can think of – house, IRA, 401k, life insurance (yes, term insurance too), etc. etc. Suffice it to say that the feds define “gross estate” quite broadly, and you may be surprised when you add it all up to learn you are at or over the $2,000,000 number. [Now, if Congress does act with respect to the estate tax, the exemption amount is likely to be much higher – many think between $3,500,000 and $5,000,000. Do you really want to count on Congress to do anything?]
Now, this is basically how a bypass trust works to save on estate taxes:
1. In either living trusts or in their will, the couple (with the help of an experienced estate planning attorney) includes the language to create the appropriate trusts.
2. While they are alive, the couple divides their assets so that they have about the same amount of assets in their own name. This is important. If a couple leaves most or all of their assets in joint accounts or in joint tenancy (as assets are often titled by married couples), they will defeat the purpose of the bypass trust.
3. If the first spouse dies in 2011, then the first $1,000,000 of his or her assets will be funded into the “bypass trust” for his non-spouse beneficiaries (usually children). This amount uses the deceased spouse’s $1,000,000 exemption (in 2011) for their benefit.
4. If the first spouse’s assets exceed $1,000,000, then the excess creates the “marital share” or “marital trust.” This defers the payment of estate taxes on the assets above the deceased spouse’s $1,000,000 exemption until after the surviving spouse’s death. You can either gift this amount outright to the spouse in the form of a “marital share” or set up a “marital trust” in the event the surviving spouses needs professional management of the assets.
5. When the surviving spouse later dies, if a federal estate tax is in effect, then the surviving spouse will still have his or her estate tax exemption. If the estate tax exemption is $1,000,000 when the surviving spouse dies, then the first $1,000,000 of the surviving spouse’s separate assets will pass estate tax free to the final beneficiaries.
6. The assets remaining in the bypass trust pass estate tax free to the final beneficiaries. You see, the bypass trust used up the $1,000,000 exemption of the first spouse to die, so anything left in the bypass trust will pass estate tax free.
So, using the bypass trust can allow married couples to pass $2,000,000 (in 2011) to their final beneficiaries free from estate tax. If Congress does increase the exemption from estate tax back to $3,500,000 or even 5,000,000, couples can save much more in estate taxes using this strategy.