HOW TO USE BYPASS TRUSTS TO SAVE $2.2 MILLION OR MORE IN ESTATE TAXES
Simple wills can cost your children over $2 Million in unnecessary taxes. Those taxes are avoidable if you leave your assets to your spouse in a special type of trust called a “bypass trust” or a “credit shelter trust.”
THREE EASY CONCEPTS
- A married person can leave any amount of assets to his or her spouse, free of Federal and State estate taxes.
- For transfers to anyone other than a spouse, everyone has an exemption. For 2015, the Federal exemption is approximately $5.4 Million. The exemption from Connecticut estate tax is $2 Million.
- The effective Federal estate tax rates on all assets over the exemption is approximately 40% on assets which are included in your estate at the time of your death. The Connecticut estate tax rates are 7.2 to 12%.
THE COST OF “ALL TO THE SURVIVOR”
Joint Ownership and "Simple" Wills
Most people are familiar with "joint" property. If you die, your spouse receives the asset. The result is the same with "all to my wife or husband" wills. If a couple's assets (including life insurance, employee pension plans, IRAs and other retirement assets, businesses, etc.) exceed the exemption amount, then joint ownership could be a tax disaster.
The Cost of Simplicity
John and Mary Smith have the following assets:
| John | Joint | Mary | |
| House | $1,500,000 | ||
| Pension & IRAs | $1,700,000 | $250,000 | |
| Cash & Securities | $600,000 | $300,000 | |
| Business | $2,000,000 | ||
| Business Real Estate | $750,000 | ||
| Summer House | $1,000,000 | ||
| Life Insurance | $1,700,000 |
With their "simple" wills and joint ownership, the survivor of John and Mary will have an estate of $9,800.000. For purposes of this illustration, we are ignoring state death taxes and administrative expenses. Please see “Connecticut estate tax,” below. Although there will be no Federal estate tax when either of John or Mary dies, their children will pay approximately $1,760,000 to receive their assets after John's and Mary's lifetimes. This tax is totally avoidable.
ILLUSTRATION:
| Survivor's Estate | = $9,800,000 |
| Estate Tax "Exemption" | = ($5,400,000) |
| Taxable Estate | = $4,400,000 |
| Approximate Tax Rate | = x 40% |
| To IRS | = $1,760,000 |
HOW TO SAVE $2.2 MILLION
The Smiths' estate tax bill is so high because they did not take advantage of both of their estate tax "exemptions."
Their neighbors, the Joneses, fared better:
DIVIDE: Bill and Jane Jones also have $9.8 Million of assets. However, they have arranged their holdings so that each of them has separate, equal shares.
CONQUER: Instead of leaving all of their assets outright to each other, they have each provided that assets equal to the "exemption" pass to a "bypass trust" for the other's benefit.
DESIGN OF BYPASS TRUST
The "bypass" trust can be designed to give your spouse as many of the benefits of outright ownership as possible while, at the same time, keeping the assets (and all appreciation) out of her estate. She could have:
- All income distributed to her.
- The right to withdraw up to 5% of the principal each year.
- If the surviving spouse is the sole trustee, she could distribute principal to herself based upon her needs for support and health care. If there were an independent trustee or co-trustee, she could receive principal distributions for almost any purpose.
- Depending on how we create the Trust, the right to direct the trustee to distribute the trust assets, either during her lifetime, or by her will, among a group of people such as your children and grandchildren. This group could also include spouses of children, nieces and nephews.
TAX SAVING ILLUSTRATION:
The Jones’ assets are the same as the Smiths’. However:
- Each of the Joneses has $4,900,000 of separate assets.
- To the extent of the estate tax exemption, they leave their assets to a bypass trust for each other’s benefit, with his remaining assets passing directly to the survivor.
- The trust is exempt from taxes in the estate of the first to die and is not included in the survivor’s taxable estate. (It does not matter how large this trust grows during the survivor’s lifetime. It will always be exempt from estate taxes.
- The survivor’s estate will include only her own assets of $4.9 Million plus appreciation.
Tax Computation - For illustrative purposes, we’re presuming that Mrs. Jones survives Mr. Jones.
| Mrs. Jones' Estate | = $4,900,000 |
| Estate Tax "Exemption" | = ($5,400,000) |
| Taxable Estate | = $0 |
Saving with Bypass Trust
Smiths' total taxes with simple wills = $1,760,000
Joneses' total taxes with bypass trusts = $0
Tax savings with bypass trusts = $1,760,000
NOTE: This is an example of leaving an amount equal to the exemption directly to a bypass trust. It is meant solely for illustrative purposes. In most cases, we use “disclaimer” based bypass trusts to increase flexibility. Please see [insert link to page on disclaimers]
WHAT ABOUT “PORTABILITY?”
For Federal (not Connecticut) purposes, a surviving spouse can, in certain circumstances, take advantage of her of his deceased mate’s unused exemption. This is commonly called “portability.” In most cases, it is not possible to foresee whether portability or a bypass trust would make the most sense. That is the primary reason why, in most cases, we allow the surviving spouse to have a choice by planning with disclaimers.
CONNECTICUT ESTATE TAX
The Connecticut estate tax, with its $2 Million exemption, obviously affects more people than the Federal tax. There is no “portability” of the Connecticut exemption. For many people, bypass trusts make sense to save the state tax.
EXAMPLE: Same facts as in the “Mr. and Mrs. Jones” illustration, except that their total assets are $3.7 Million. If the survivor ends up with all of the assets, the Connecticut tax would be $128,000. This is, in a sense a voluntary contribution to the state because it can be totally avoided using a bypass trust.