Estate Planning
The Bypass Trust
To avoid wasting your unified credit and incurring an unnecessary estate tax, we often recommend that you consider the use of a trust commonly referred to as a "By-Pass Trust" or "Credit Shelter Trust." The Bypass Trust is designed so that it does not qualify for the marital deduction, thereby causing the assets of the Bypass Trust to be taxable in your estate. This creates an estate tax obligation, which will be offset by your unified credit. Moreover, the Bypass
Trust is designed so that it will not be included in your surviving spouse's estate. A $2,000,000 Bypass Trust will permit you to take full advantage of the unified credit without causing this amount to be taxed in your spouse's estate upon the second death.
Although the assets in a Bypass Trust will not be included in your spouse's estate, he or she can enjoy virtual ownership of the trust property through the following interests:
(a) Income: Your spouse can be designated as the sole income beneficiary, thus, receiving all the income from the assets of the Bypass Trust during his or her lifetime.
(b) Discretionary Invasion of Principal: A third party trustee may be authorized to invade principal for the benefit of your spouse. This provides your spouse with the benefit trust principal if needed in an emergency.
(c) Right to Withdraw $5,000 or 5%: Your spouse may be authorized to make annual withdrawals of principal, for any reason, up to the greater of $5,000 or five percent (5%) of the Bypass Trust. This right lapses each year if not exercised. Possessing such a right will cause the greater $5,000 or 5% of the Bypass Trust to be included in your spouse's estate, but this gives your spouse additional access to principal at a nominal estate tax cost.
(d) Special Power of Appointment. Your spouse may be authorized to control the ultimate disposition of the trust through a special power of appointment, which permits her to designate the final trust beneficiaries. The only limit to this power is that it may not be used to transfer assets to your spouse, his or her creditors, his or her estate or the creditors of his or her estate. This gives your spouse the advantage of a "second look" and permits modifications to the dispositive provisions of the Bypass Trust based on unforeseen circumstances, which may occur after your death.
(e) Trustee: Your spouse may be designated as trustee of the Bypass Trust, although it is generally preferable for another disinterested third party to serve as co‑trustee. If your spouse is trustee, any discretionary right to invade principal for her own benefit must be limited by an "ascertainable standard". An example of such a standard is the power to invade for the purpose of your spouse's "health, support and maintenance". Such a standard is legally enforceable and will prevent the trust from being included in your spouse's estate.
(f) Bypass of Spouse's Estate: If properly drafted and administered, this trust will bypass your spouse's estate because all of his or her interests in this trust terminate at death leaving nothing of value to be included in his or her estate, except the amount of any right to withdraw $5,000 or 5% of principal.