Do I need a Bypass? [Trust]

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Topic Author
jimmy
Posts: 69
Joined: Sat Apr 27, 2013 1:29 am

Do I need a Bypass? [Trust]

Post by jimmy »

Here's the situation:

Husband passed away late last year. Wife is mid 60's. Total estate is 6.5 million.
2M in IRA which is now in wife's name
2M Several Index Funds with Vanguard
2M Bank accounts
1.5M House

This is approximately where the assets are. All non-IRA money is in a Family trust. The attorney has instructed to put the bank and investments into the Bypass trust with only the house and personal assets in the Survivors Trust, leaving her no liquid money in the Survivors Trust. My question is does she really need a bypass with the 5.12M exemption and portability clause of 10M or is this something she should still do. She has gotten very confused on how this is structured and it's causing her a lot of stress and lots of attorney and accounting fee's (over 10K so far and more pending)which she assumes will continue for years. They have one daughter who will be the sole heir at the surviving wife's death. They live in CA.. Would love to hear some others advise on this?
MathWizard
Posts: 6542
Joined: Tue Jul 26, 2011 1:35 pm

Re: Do I need a Bypass?

Post by MathWizard »

This is the tax tail wagging the dog.

The attorney is saying to avoid expenses after death (taxes) but pay him/her attorney expenses
now, and tie up the money. No advisor should be causing her distress. She has plenty of money,
why should the attorney be causing her grief?

I'd forget such a scheme and the associated lawyer fees and stress. She should just keep the
money in her own name and spend down to the exclusion limit. She can also begin gifting the max
($10K or more each year) to heir, and that will not affect the estate tax exclusion.

Any 529 plans she can contribute to?
bsteiner
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Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: Do I need a Bypass?

Post by bsteiner »

jimmy wrote:Husband passed away late last year. Wife is mid 60's. Total estate is 6.5 million.
2M in IRA which is now in wife's name
2M Several Index Funds with Vanguard
2M Bank accounts
1.5M House

This is approximately where the assets are. All non-IRA money is in a Family trust. The attorney has instructed to put the bank and investments into the Bypass trust with only the house and personal assets in the Survivors Trust, leaving her no liquid money in the Survivors Trust. My question is does she really need a bypass with the 5.12M exemption and portability clause of 10M or is this something she should still do. She has gotten very confused on how this is structured and it's causing her a lot of stress and lots of attorney and accounting fee's (over 10K so far and more pending) which she assumes will continue for years. They have one daughter who will be the sole heir at the surviving wife's death. They live in CA. Would love to hear some others advise on this?
The assets you describe add up to $7.5 million rather than $6.5 million. I assume the $6.5 million figure was a typo.

You didn't say what the Will (or, since they're in California, perhaps the revocable trust) provides. I assume (since otherwise your question would be moot) it provides either (i) a credit shelter (bypass) trust, with the surviving spouse's co-trustee having complete discretion to distribute the assets of the credit shelter trust to the spouse, or (ii) a disclaimer trust to receive any assets that the surviving spouse might disclaim.

Since you said they're in California, I assume that the assets are all community property, so that each spouse's share of the community property is $3.75 million, so that the credit shelter trust could have $3.75 million.

I don't practice in California, but lawyers in California have told me that it's possible to divide the community property non pro rata, so that the surviving spouse can end up with all of the retirement benefits as part of her share of the community property. If that's correct (or if the deceased spouse left the IRA to the surviving spouse), that's a good result, since the spouse can roll it over, name new beneficiaries, and perhaps convert to a Roth.

As to your principal question, whether to maintain the $3.75 million credit shelter trust, on these numbers, that's an easy choice. The credit shelter trust will keep the assets out of the surviving spouse's estate. Portability is not indexed for inflation. There is no portability for generation-skipping transfer (GST) tax purposes. The credit shelter trust will also be protected against creditors, including future spouses.

If the entire estate goes to the surviving spouse, his/her estate could end up more than her exempt amount ($5.25 million, indexed) plus his unused exempt amount ($5.25 million, not indexed). It's also possible that the exempt amount might not be $5.25 million (indexed) at the surviving spouse's death. The Admininstration has proposed to reduce it to $3.5 million (not indexed) beginnning in 2018. If the surviving spouse is in her mid-60s, that could be 30 years from now. There's no way to predict what the law will be then.

Edited to reflect Eric's comments. Portability won't be available for the amount of any assets going into the credit shelter trust and then distributed to the spouse. However, it will be available to the extent his assets are payable to his wife and only to the credit shelter trust to the extent she disclaims, and she doesn't disclaim. It will also be available for a mandatory credit shelter trust if all of the beneficiaries of the credit shelter trust disclaim and the disclaimed property passes to the spouse as a result of the disclaimers (though, depending on the terms of the Will, or perhaps the revocable trust since they're in California, the disclaimed property might go to someone other than the spouse).

Given the amount involved, having the credit shelter trust be GST exempt (and out of the daughter's estate) may provide a substantial estate tax benefit in the daughter's estate.

The tradeoff is that the credit shelter trust may be subject to income tax at a higher rate than the spouse, and the assets in the credit shelter trust won't get another basis step-up at the surviving spouse's death. I think that's a small price to pay for the estate tax and asset protection benefits of the credit shelter trust. If it turns out that these benefits aren't necessary, or are only partially necessary, the trustees can distribute some or all of the income to the spouse, and can distribute the highly appreciated assets to the surviving spouse. However, if the credit shelter trust isn't set up, or if the credit shelter trust assets are distributed to the spouse, you can't put them back in.

As to whether to give the residence to the spouse as part of her share or put it in the credit shelter trust as part of its share, there are advantages and disadvantages of either choice. The lawyer should present the advantages and disadvantages of the alternatives to her and let her decide.

The trust will also have to file annual fiduciary income tax returns. However, the cost of that is relatively small.

The legal fees will be about the same regardless of whether the credit shelter trust is established. The lawyer will have to ascertain the assets, prepare the estate tax return (to elect portability), discuss these issues with the surviving spouse, and then arrange for the asset transfers. They're likely to be substantially more than $10,000. However, they're unlikely to continue once the estate tax return is filed and these issues are resolved.
Last edited by bsteiner on Fri May 17, 2013 11:46 am, edited 2 times in total.
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Eric
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Re: Do I need a Bypass?

Post by Eric »

To Bruce's excellent response, I would add that the opportunity to use "exemption portability" here is already largely lost. Per the OP, Husband has already died. His estate plan directs that a bypass trust be established. The amount directed to go to the bypass trust will use up a large part of Husband's estate tax exemption, whether the bypass trust is funded or not. So if the surviving spouse wants to preserve that part of the exemption, the only way to do so at this point is to fund and preserve the bypass trust. (My comments here assume that the bypass trust has fairly typical terms and that it is not possible under the trust document to elect a marital deduction for the bypass trust.)

Also, there are fiduciary concerns, depending on the trust instrument. Funding normally isn't elective.

As always, this isn't legal advice, and I encourage you to discuss this more with the lawyer who is actually on the case (or if he is not your lawyer, with a lawyer of your own).
Topic Author
jimmy
Posts: 69
Joined: Sat Apr 27, 2013 1:29 am

Re: Do I need a Bypass?

Post by jimmy »

Thanks for all the responses and education. I guess what I'm really trying to wrap my head around is if it's worth it to have a Bypass Trust with all the extra administrative work, higher taxes (at the trust level) and no step up in basis vs. no admin work, lower taxes at individual level, step up in basis at death with potential to have estate taxes?? I guess it's better safe than sorry since we don't know the future. What is the size of an estate where a Bypass is recommended? I've seen people with Bypass trusts with estates under 2MM and it doesn't make sense to me.. I know this isn't the most exciting conversation but thanks for all the feedback. :sharebeer
MN Finance
Posts: 1926
Joined: Sat Dec 22, 2012 9:46 am

Re: Do I need a Bypass? [Trust]

Post by MN Finance »

I won't add to the details already provided but depending on who this person is and what your relationship is, the best advice would be to have you (or another advocate) meet with her and the attorney to better understand the advice. The details mean everything, so it's hard to speculate here and give advice. If an unemotional 3rd party is there, they can much more easily gain understanding from the attorney. It seems unlikely they would be making recommendations just to increase current legal costs (though I suppose that's possible).
bsteiner
Posts: 9153
Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: Do I need a Bypass?

Post by bsteiner »

jimmy wrote:Thanks for all the responses and education. I guess what I'm really trying to wrap my head around is if it's worth it to have a Bypass Trust with all the extra administrative work, higher taxes (at the trust level) and no step up in basis vs. no admin work, lower taxes at individual level, step up in basis at death with potential to have estate taxes?? I guess it's better safe than sorry since we don't know the future. What is the size of an estate where a Bypass is recommended? I've seen people with Bypass trusts with estates under 2MM and it doesn't make sense to me.. I know this isn't the most exciting conversation but thanks for all the feedback. :sharebeer
The analysis is different in states having a state estate tax with an exempt amount lower than the Federal exempt amount. For example, New York has an estate tax with a $1 million exempt amount. The New York estate tax on a $2 million estate is about $100,000, while the New York estate tax on two $1 million estates is zero. So in New York we would almost always shelter the $1 million New York exempt amount in smaller estates, and the Federal exempt amount (currently $5.25 million) in larger estates.

In a state that doesn't have a state estate tax, we would shelter the Federal exempt amount in larger estates.

In a state that doesn't have a state estate tax, the client has to weigh the possible estate tax, GST tax and asset protection benefits of the credit shelter trust against the income tax costs of the credit shelter trust. The administration costs are modest, generally just the cost of an annual fiduciary income tax return. Some older clients with modest estates want the protection against Medicaid. Some younger clients with modest estates want the protection against the surviving spouse remarrying. Others will leave their estates to each other, saying that, with portability, the possible estate tax, GST tax and asset protection benefits of the credit shelter trust aren't worth the income tax cost of the credit shelter trust.

Some clients with modest estates leave the decision to the surviving spouse, by leaving their estates to each other, and providing that any assets that the surviving spouse disclaims will go into a credit shelter trust having the necessary provisions to receive assets as a result of a disclaimer.
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