What Is a Bypass Trust? How It Works in an Estate Plan

A bypass trust can help ensure that your assets end up where you want them to go after you die.
Tina Orem
By Tina Orem 
Published
Edited by Claire Tsosie

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What is a bypass trust?

A bypass trust is an estate planning tool for married couples in which a spouse’s share of the estate transfers to a trust at death. The surviving spouse may get income from and use the trust assets; however, the trust’s beneficiaries inherit the assets when that spouse dies.

Though originally intended to minimize estate taxes, today people often use bypass trusts to shield assets from specific people due to tax law changes.

How a bypass trust works

To create a bypass trust, each spouse includes a provision in their will that creates a trust for the surviving spouse’s benefit and funds that trust with an amount up to the estate tax exemption. When the surviving spouse later dies, whatever is left in that trust at that point typically goes to the first spouse's designated beneficiaries

The assets typically move to the surviving spouse free from estate tax through the trust. When the surviving spouse dies, they then pass to the beneficiaries, free from estate tax.

Estate tax is a tax levied on a deceased person's assets over a certain amount. The federal estate tax ranges from rates of 18% to 40% and generally only applies to assets over $12.92 million in 2023 or $13.61 million in 2024. That exemption is per person.

Bypass trusts were often helpful in minimizing federal estate taxes. However, in 2010, federal estate tax laws began allowing “portability” of the estate tax exemption, meaning a spouse could “inherit” the unused portion of the other spouse’s estate tax exemption. This is called the deceased spousal unused exclusion amount, or DSUE.

Internal Revenue Service. Rev. Proc. 2022-32. Accessed Feb 23, 2023.
This change meant that surviving spouses could end up with significantly larger estate tax exemptions, which, combined with increases in the size of the federal estate tax exemption itself over time, have rendered bypass trusts relatively less effective for managing federal estate taxes.

However, bypass trusts do have other uses.

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Advantages of a bypass trust

  • Minimize state-level estate taxes. Most people probably don’t have estates large enough to trigger federal estate tax, but they may owe considerable estate taxes to the state. That’s because some states have their own estate taxes, and the exemption thresholds can be far lower than the federal threshold. In those cases, a bypass trust might help minimize state-level estate taxes.

    American Bar Association. A-B trust planning. Accessed Feb 23, 2023.

  • Keep the decedent’s assets away from someone else’s creditors. If the surviving spouse remarries someone with a lot of debt, creditors may come after the surviving spouse’s assets if the new partner falls behind on the payments. A bypass trust could shield those assets from creditors. Bypass trusts are sometimes called credit shelter trusts.

  • Ensure the kids actually get the assets. If the surviving spouse remarries someone who has kids from another relationship, those children might receive the decedent’s assets as part of their inheritance when the surviving spouse dies. A bypass trust can arrange for the assets to go only to the decedent’s own children even if the surviving spouse remarries.

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Price (one-time)

$89 for Basic will plan, $99 for Comprehensive will plan, $249 for Estate Plan Bundle.

Price (one-time)

Will: one-time fee of $199 per individual or $299 for couples. Trust: one-time fee of $499 per individual or $599 for couples.

Price (annual)

None

Price (annual)

$19 annual membership fee.

Access to attorney support

Yes

Access to attorney support

Yes

Disadvantages of a bypass trust

  • Time and expense. Creating a bypass trust typically requires paying an estate planning attorney to handle the paperwork. That can cost hundreds or thousands of dollars and involve one or more appointments with the attorney.

  • Potentially higher capital gains tax for your beneficiaries. People who inherit financial assets often sell them later, and if they sell them at a profit, they may owe capital gains tax. Typically, the IRS views the original cost of those assets (the cost basis) as the market value of those assets on the day the person inherited them (rather than what the decedent originally paid for them). This “step-up in basis” makes the profit from a sale of those assets look smaller to the Internal Revenue Service and thus can shrink the potential capital gains tax. However, assets inherited from bypass trusts don’t get a step-up in basis, so beneficiaries might pay more capital gains tax than if they had inherited the assets from outside the trust.

    Pennsylvania Institute of Certified Public Accountants. CPA Now. Accessed Feb 23, 2023.

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