Estate Planning: Bypass Trust ("B" Trust) - T. Rowe Price

It is highly likely that if you are married* and have had a will prepared for you in the past by an estate planning attorney that the will includes a bypass trust (also called a "family" or "credit shelter" or "B" trust). This type of trust is designed to help your family save on estate taxes. In your will and your spouse's will, each of you directs that if you are the first spouse to die that your solely owned assets be used to fund this type of trust with up to whatever the personal estate exemption amount is at the time ($5.25 million each in 2013) . Examples of assets that were used to fund these trusts are probate assets, assets already in a revocable living trust, or assets with the proceeds of a life insurance policy or retirement account(s) in which you name the bypass trust as beneficiary.

The bypass trust can be used to provide income to your spouse and/or other family members during the surviving spouse's lifetime. Subject to certain restrictions, you also are able to grant the trustee the power to distribute trust principal for particular needs of your spouse and/or other beneficiaries. If properly structured, the assets in the trust would not be included in your surviving spouse's estate—and would then "bypass" your spouse's taxable estate at his or her death and pass estate-tax free to the beneficiaries of the trust, even if the trust had grown significantly larger than the original exemption amount used to fund the trust at your death.

Any amount in excess of the current federal estate tax exemption amount that is used to fund a bypass trust is usually distributed outright to the surviving spouse or is used to fund a marital trust or qualified terminable interest property (QTIP) trust.

In the past, when a will did not include a bypass trust or when there was not sufficient solely-owned assets to fund it, the estate tax exemption of the first spouse to die is essentially wasted. Starting in 2013, however, the necessity for including a bypass trust in your will if you are married has been eliminated. The new law allows the surviving spouse to utilize the first spouse's unused estate tax exemption amount without the need to use a bypass trust, but to do so the surviving spouse must complete and file certain paperwork with the IRS after the death of the first spouse. This is referred to as a "portability" provision.

Nevertheless, even with this law, bypass trusts can offer advantages for some investors with relatively large estates. For example, if the portability provision, rather than a bypass trust, is used, growth in the assets are not excluded from the gross estate of the surviving spouse and may run up against the estate tax exemption amount in effect when the surviving spouse dies. Or, if the surviving spouse remarries and is the survivor of that subsequent marriage, the unused exclusion from the first marriage will be lost. Also, keep in mind that for both bypass trusts and the portability strategy, any lifetime gifts you make that are taxable will decrease your estate tax exemption amount, thus decreasing the amount that can be put into a bypass trust at your death or the amount that your spouse can use under the portability strategy.

*If you are married and you and your spouse are both US citizens. If one spouse is not a U.S. citizen, different marital deduction rules apply. Consult an estate planning attorney or tax advisor for further details.