The rise in the stock market over the past several years, teamed with the passage of the SECURE Act two years ago—as well as the scheduled 50% reduction in the size of the federal estate tax exemption four years from now—has resulted in a renewed interest in estate planning for IRA and 401(k) accounts owned by married couples. For couples owning significant IRA and 401(k) accounts, the question is whether they should now consider paying all or a portion of these to a so-called "bypass" trust for the benefit of the surviving spouse. This strategy removes the designated portion of the IRA or 401(k) proceeds from the surviving spouse's taxable estate, besides achieving certain other non-tax objectives.

Limitations Of The Spousal Portability Election
In 2013, Congress permanently passed into law what is known as the portability election for assets passing outright to the surviving spouse when the other one dies. Portability allows the survivor to use the unused federal estate tax exemption of the deceased spouse, and thus claim two estate tax exemptions.

Given the obvious beneficial aspects of this now nine-year-old law, why is there any longer a need for a married couple to consider using a bypass trust in their estate planning?

There are actually at least five reasons:

1.  The portability election will not remove appreciation in the value of the "ported" assets from the surviving spouse's taxable estate, whereas a bypass trust will remove all appreciation. 

2.  The portability election will not apply (at least for the deceased spouse’s unused estate tax exemption) if the surviving spouse remarries and the new spouse predeceases him or her, whereas the remarriage of the surviving spouse is irrelevant in the case of assets transferred to a bypass trust.

3. The portability election will not apply for federal generation-skipping transfer tax purposes, meaning the amount that could have passed to an estate and generation-skipping transfer tax-exempt bypass trust, including all appreciation in its value, could then be subject to federal transfer tax in the children's estates.

4. Using the portability election would cause the "ported" assets to be subject to potential lawsuits against the surviving spouse as well as to the potential claims of a new spouse, whereas lawsuits and claims against a surviving spouse would be avoided if a bypass trust is used. 

5.  The portability election would mean the first spouse to die would lose the ability to control where the "ported" assets pass at the surviving spouse's death, control that could have been retained had a bypass trust been used instead.

The Traditional Bypass Trust As An Alternative
Obviously, there are limitations in the spousal portability election when you compare them with "bypass trust planning," in which married couples divide their assets in some fashion so that, at the death of the first spouse, all or a portion of his or her separate assets pass to an estate tax-exempt trust for the survivor. The latter type of planning is obviously still in play since the 2013 change to the law. The question is: Are bypass trusts an appropriate receptacle for IRA and 401(k) plan proceeds given that, after the SECURE Act, these trusts are generally subject to a 10-year maximum payout rule, whereas the outright payment of IRA and 401(k) plan proceeds to a surviving spouse is entitled to spousal rollover treatment, and therefore greater income tax deferral? Furthermore, bypass trusts are generally subject to the highest federal income tax rate at levels of gross income of as low as only $13,550; they include an exemption of only $100, and do not qualify for income tax basis step-up at the surviving spouse's death.

First « 1 2 » Next