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Should you set up a bypass trust in California

On Behalf of | Oct 14, 2022 | Estate Planning, Trust Administration |

Bypass trusts are an estate planning strategy that could benefit wealthy couples or people who have children from a previous marriage. This type of trust shelters your assets from federal estate tax up to the exemption amount, and it allows you to include other beneficiaries besides your spouse.

Two trusts

When you set up a bypass trust, you’re actually establishing two trusts: A and B. The A trust goes toward the surviving spouse, and the B trust is for other beneficiaries. Your spouse would have the right to modify and use the A trust. The B trust, in contrast, is irrevocable.

Estate planning law allows you to nominate your spouse as the trustee of the B trust. As the trustee, they oversee the management of the funds, but they can’t use them for their own benefit or change the terms. Assets in the A trust aren’t subject to estate tax because they pass on to your surviving spouse. IRS taxes the B trust if it exceeds the estate tax exemption.

Estate taxes

Some people automatically assume that they don’t need a bypass trust because their surviving spouse inherits their estate tax-free. However, what makes a bypass trust helpful is it prevents estate tax once the surviving spouse dies. This means that you could let beneficiaries that come after your surviving spouse keep more of the estate.

No probate

Just as with other types of trusts, bypass trusts don’t go through probate. Trusts transfer to the beneficiaries by default when you die.

Downsides of a bypass trust

It might not make financial sense to set up a bypass trust if you don’t have a highly valued estate. If you don’t want to manage the trust as a trustee, then you would have to factor in paying someone from the trust’s funds.

A bypass trust could help you reduce your estate tax burden when you intend to pass on assets to your spouse and other beneficiaries. Although spouses get a tax exemption on their portion, a bypass trust prevents their beneficiaries from having to pay taxes too.