For the past ten years, the federal estate tax rules have been changing and they will shift again on January 1, 2011. As of that date, the federal estate tax will return with a $1 million exemption and rate of 37-55%. Thus, virtually everyone with assets in excess of $1 million should have their estate plan reviewed.
Bypass Trust Arrangements Can Save Estate Taxes
Married couples concerned about estate taxes can set up a bypass trust arrangement in their wills or living trust documents. (Bypass trusts are also commonly called credit shelter trusts).
The main purpose of a bypass trust is to allow both spouses to take advantage of their respective federal estate tax exemptions. Typically, assets with value equal to the current exemption amount are automatically put into the bypass trust when the first spouse dies. The trust is created at that time and is irrevocable.
The beneficiaries of the trust are designated by the first spouse to die, and the assets used to fund the trust come out of that person's estate when death occurs. Typically, the trust beneficiaries are that person's children and/or grandchildren.
Since the first spouse to die designates the beneficiaries of the bypass trust, the assets used to fund the trust are included in that person's estate for federal estate tax purposes. However, no federal estate tax is due because that person's estate tax exemption provides sufficient shelter.
The surviving spouse can be given money from the bypass trust to meet his or her reasonable financial needs. When the surviving spouse passes away, the remaining assets in the bypass trust go the beneficiaries of the trust (such as the children and/or grandchildren).
A Potential Problem
Even with properly drafted bypass trust provisions, asset ownership and beneficiary designations must be coordinated with the intent of the estate plan so that assets are available to be sheltered in the bypass trust at the death of the first spouse to die. This asset allocation is a crucial part of any estate plan.
The Bottom Line
Throughout your life, your estate plan will have to be altered at times due to tax changes and other events. Some situations are inherently unpredictable--like winning the lottery or losing a bundle in the stock market. However, it's a fact that the federal estate tax laws are in flux and proper planning is needed. Anyone with assets over $1 million who has not had their plan created or updated after January 1, 2010 with the return of the estate tax (with a $1 million exemption) factored in should schedule an appointment for a review to see what, if any, changes are advisable. This is particularly important for married couples.
P.S. Remember that the proceeds of life insurance policies are taxable for federal estate tax purposes.