Lifetime Bypass Trust


Until December 31, the lifetime gift tax exclusion is $5,120,000 per person. Unless Congress acts, this amount will drop to $1,000,000 on January 1, 2013.  It is usually best to use a tax exemption as soon as possible – use it or lose it.

The opportunity, good now through the December 31, is to gift assets out of your estate and forever exempt the assets and all future appreciation from estate tax.

When we explain this to our clients with medium to large estates, they understand the value and urgency of gifting now, but many of them need the assets to live on.  What good is it to give your children your assets when you still need your assets?

Enter the Lifetime Bypass Trust, also known as the spousal lifetime access trust. A lifetime bypass trust is an irrevocable trust that names your spouse as trustee and your spouse and children as beneficiaries. The assets you gift to the trust, and all future appreciation, will be exempt from estate tax.  Until December 31, you can gift up to $5,120,000 to the trust, although many of our clients gift less.

This is the “have your cake and eat it too trust.” The trust assets will be exempt from estate tax when you die, when your spouse dies, and when your children die. In addition, you will retain indirect control and use of the assets because your spouse is the trustee and beneficiary. And if your spouse sets up a similar trust for you, you would have direct control and access to that trust’s assets as trustee and beneficiary, and those assets would also be exempt from estate tax.

Another way to look at it. You gift assets to a trust for your spouse, and your spouse gifts assets to a trust for you. You each control and benefit from each other’s trust, and the assets in each trust will be exempt from estate tax. What a deal!

Just like the A/B trust. You may be familiar with the basic estate tax concept of the A/B trust. When the first spouse dies, a bypass trust (B trust) is funded with the deceased spouse’s share of the estate. By using the deceased spouse’s estate tax exclusion, the assets in the bypass trust are exempt from estate tax. The surviving spouse is typically the trustee and the primary beneficiary. This gives the surviving spouse control and use of the bypass trust assets, yet the assets remain exempt from estate tax.

The lifetime exemption trust uses the same principle as the bypass trust, but instead of creating and funding it at death, it is created and funded now (before December 31) using some or all of each spouse’s lifetime gift exclusion.

Be careful. If each spouse creates a trust for the other, the trusts must be drafted to avoid the reciprocal trust doctrine. If the IRS finds the trusts identical, it will disregard them and pull the assets back into the donor’s estate. To avoid this, we make the trusts different. For example: the trusts could be funded with different assets, the husband could be given a right to income while the wife is given the right to income and principal, the wife could be given a power to name additional beneficiaries and the husband not given that power, or each trust could have different successor trustees or remainder beneficiaries. There are a number of ways the reciprocal trust doctrine can be circumvented based on your unique situation.

Additional benefits. The assets in the lifetime protection trusts would be significantly protected from lawsuits and divorce claims. So in addition to reducing your estate tax liability, you would be gaining significant asset protection.

Deadline looms. The lifetime bypass trust is a terrific tool to reduce or eliminate estate tax. But it must be created and funded before December 31, 2012.

Keep in mind it typically takes about three weeks to establish and fund a lifetime bypass trust. If this strategy appeals to you, you must act now, as time is running out.

8. You Can Give Your Children Divorce and Asset Protection

This is part 8 in my series, Estate Planning – What You Need to Know.

Part 8 – You Can Give Your Children Divorce and Asset Protection.

Of the thousands of clients I’ve worked with, most know how they want to distribute their assets when they die:

 For married couples, it’s usually to the surviving spouse and then in equal shares to their children.

 For a divorced client or widow, it’s usually in equal shares to his or her children.

Is that enough planning? Does that protect your children?

Determining who gets what is only half the task of good estate planning. Equally, if not more important, is determining how your loved ones will receive their inheritance.

Divorcing Spouses and Plaintiffs

If your child receives his or her share of your estate outright, it will be subject to claims of divorcing spouses, creditors and plaintiff’s attorneys.

If your child is married and receives an inheritance, nine times out of ten, he or she will place the inherited assets (say a check) in a joint account with his or her spouse.

California is a community property state which means all property acquired during marriage is considered owned one-half by each spouse subject to a few exceptions. One of these exceptions is an inheritance.

Inherited property is separate property. However, the separate property is transmuted to community property when your son or daughter transfers it to an account owned jointly with the spouse.

No problem as long as the marriage is solid.

But if the marriage ends, the spouse will claim half of the inherited property as his or her share.

Most parents would not choose to leave half of their child’s inheritance to a divorcing spouse.

If your child receives the inheritance while single and subsequently gets engaged, does he or she write a prenuptial agreement to maintain the inherited property as separate property?

Without a prenuptial agreement, your son or daughter will have to keep the property in a separate account and field questions from his or her fiancé and then spouse about why it’s not in a joint account. (Question: “Why do you keep your inheritance in a separate account?” Answer: “Don’t worry honey, it’s just in case we get divorced.” I wouldn’t wish that conversation on anyone.)

In my experience, the only couples that sign prenuptial agreements are those that are on their third or forth marriage.

Another matter to consider is lawsuits. When your son or daughter receives an inheritance outright, the property is in his or her name. If he or she is ever sued, the inheritance is subject to the claims of the plaintiff. It’s fair game in a lawsuit.

Solution – Lifetime Inheritance Trusts

Instead of distributing your estate to your children outright, you should consider leaving their share to them in a lifetime protection trust.

Lifetime inheritance trusts are created with special provisions in your revocable living trust.

Your revocable living trust will include instructions for your trustee to create separate trusts (we call them “lifetime protection trusts”) for each of your children when you pass away.

The trustee will then allocate the inheritance to those separate trusts for each child, rather than outright to each child.

If your child is old enough, she can be the trustee of her own trust. The trust, rather than the child, will own the property.

The significance of this is truly amazing.

Divorcing Spouse. Let’s say your son has a rocky marriage. You were savvy enough to include lifetime protection trust provisions in your living trust. When you pass away, your son receives his inheritance in trust, not outright. So his divorcing wife will have a real tough time getting her claws on it.

The trust can also be drafted to distribute the trust property in separate trusts for your grandchildren upon the death of your child in a way that will avoid further estate taxes. This protects the original inheritance from more estate taxes and from a divorcing spouse, and it provides a legacy for the grandchildren.

To Prenup or Not to Prenup. If your daughter is engaged and receives her inheritance in trust, there will be less need for a prenuptial agreement with her fiancé. The inheritance is already set aside and significantly protected in the trust. Your daughter may not even have to address the issue.

Keep the Attorneys Away. The lifetime protection trust will also serve as a deterrent to plaintiff’s attorneys.

Your child does not really own the trust property – the trust does. If your son is sued, be it a professional business claim or a vehicle accident or you name it, the trust property will be significantly protected.

Your son has a right to receive trust distributions at the discretion of the trustee, but during a lawsuit, the trustee will make no distributions, so there will be nothing for the plaintiff to attach.

The trust substantially removes the inheritance from your son’s attachable assets.

Unless the estate is very small with no life insurance, I usually recommend my clients include provisions to create lifetime protection trusts for their children in their revocable living trust.

Bottom line. If you’re going to do your estate planning, why not take the extra step to protect the inheritance?