Funding a bypass trust

[SecondCor521]

Scenario:

A couple has a bypass trust established in their wills.

Husband has a $2M traditional IRA and is taking RMDs. Primary beneficiary on traditional IRA is Wife, secondary beneficiary is three kids in thirds.

If Husband dies, I understand that the trad IRA goes to wife and she can employ the stretch IRA technique.

True/False Questions (with my guesses):

1. The $2M has not funded the bypass trust in this case because it didn't pass through probate. (True)
2. Only assets that pass through probate can be used to fund the bypass trust. (True)
3. If the primary beneficiary were changed to Husband's estate,
a. it could be used to fund the bypass trust (True)
b. it would preserve the Husband's estate tax exemption (True)
c. It would prevent the use of the stretch IRA technique (True)
4. If the primary beneficiary were changed to the bypass trust,
a. it could be used to fund the bypass trust (True)
b. it would preserve the Husband's estate tax exemption (True)
c. It would prevent the use of the stretch IRA technique (True)

Thanks,

2Cor521

 

[Martha]

I think you pretty much have it right. The key isn't probate though, it is how do assets get passed along. If the IRA has the trust as a beneficiary, then the trust automatically is the beneficiary. Probate is irrelevant. If the IRA has no beneficiaries, then it goes to the estate and is moved out according to the will. If the wife is the beneficiary, then she gets the IRA and has the opportunity to roll it over into her own IRA.

As you are aware, the problem with having the wife as beneficiary is that the husband, if he doesn't have other assets to fund a bypass trust, does not get to use his estate tax exemption and the wife when she dies may be hit with a big tax. However, there are tax advantages in having the wife be the beneficiary of the IRA.

There are a number of things that can be done to plan for that possibility. The wife, if the husband dies first, may chose to disclaim a percentage of the IRA to move part into a trust. The trust then should be named as the contingent beneficiary. The decision to disclaim doesn't have to be made until the husband dies.

These things get complicated and are effected by a number of factors so estate planning attorneys should be consulted.

 

[SecondCor521]

Martha, one quick question:

When you say the key isn't probate, you've confused me a bit. I'm not sure if you're referring to estate tax exemptions or to how the money is passed down. Let me try to ask a set of clarifying questions:

1. Assuming Husband dies first and wishes to preserve his lifetime estate tax exemption. In order to fulfill the estate tax exemption, do those dollars need to:
a. Pass through probate? (Yes?)
b. End up in the bypass trust? (Yes?)

Yes, this is a complicated situation and I am neither an attorney or any sort of estate planning person...I just pick up what I can from my MBA law class and things like Kiplinger's.

The fact is I am one of the children in this case, and after thinking about it a little, if my parents have messed up funding the bypass trust I think it will just affect us kids when the second parent passes away. My parents care about avoiding estate taxes when at all possible, but I would neither expect nor want them to cause issues for themselves while one or both are still living in order to avoid them.

They have consulted both with their estate lawyer and their CPA, both of whom are very sharp in their fields I think, and my parents are simply following their recommendations. It's just that in my simple mind, if the IRA beneficiaries are Mom first and then kids second, then (a) the bypass trust isn't funded and (2) Mom disclaiming wouldn't work (because it then would go to the kids, right?).

It's a little delicate to try to address this, because, as I said, the problem really only affects us kids, they've already consulted their experts, and I don't want to seem too mercenary. But I do know that my parents very much dislike paying taxes in general and the estate tax in particular, because they have taken a number of definite steps to try to avoid the darn thing.

The situation is further complicated by other IRA's and taxable accounts, and because I want to respect their privacy I don't want to spill even the general details here on a message board in order to get the kind of advice I really need. I may just need to ask their permission to talk to their estate planning attorney.

2Cor521

 

[Martha]

Martha, one quick question:

When you say the key isn't probate, you've confused me a bit. I'm not sure if you're referring to estate tax exemptions or to how the money is passed down. Let me try to ask a set of clarifying questions:

1. Assuming Husband dies first and wishes to preserve his lifetime estate tax exemption. In order to fulfill the estate tax exemption, do those dollars need to:
a. Pass through probate? (Yes?)
b. End up in the bypass trust? (Yes?)

In order to preserve his exemption, he wants to make sure not everything passes to his wife. One way to do this is through the bypass trust. An asset may or may not have to go through probate to end up in the bypass trust. For example, If an IRA has the trust as beneficiary, then the IRA passes into the trust without a probate. Similarly, if an IRA had the wife as primary beneficiary and the trust as secondary, and the wife disclaims a percentage of the IRA, the remainder passes to the bypass trust without probate. It is automatic.

Yes, this is a complicated situation and I am neither an attorney or any sort of estate planning person...I just pick up what I can from my MBA law class and things like Kiplinger's.

The fact is I am one of the children in this case, and after thinking about it a little, if my parents have messed up funding the bypass trust I think it will just affect us kids when the second parent passes away. My parents care about avoiding estate taxes when at all possible, but I would neither expect nor want them to cause issues for themselves while one or both are still living in order to avoid them.

They have consulted both with their estate lawyer and their CPA, both of whom are very sharp in their fields I think, and my parents are simply following their recommendations. It's just that in my simple mind, if the IRA beneficiaries are Mom first and then kids second, then (a) the bypass trust isn't funded and (2) Mom disclaiming wouldn't work (because it then would go to the kids, right?).

Right.

It's a little delicate to try to address this, because, as I said, the problem really only affects us kids, they've already consulted their experts, and I don't want to seem too mercenary. But I do know that my parents very much dislike paying taxes in general and the estate tax in particular, because they have taken a number of definite steps to try to avoid the darn thing.

The situation is further complicated by other IRA's and taxable accounts, and because I want to respect their privacy I don't want to spill even the general details here on a message board in order to get the kind of advice I really need. I may just need to ask their permission to talk to their estate planning attorney.

2Cor521

This is a good idea. Though I know these things are awkward. There is no way to get enough information here to be helpful for the specific situation.