The rise in the stock market over the past several years, teamed with the passage of the SECURE Act two years ago and 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 401k accounts owned by married couples.
For married couples who own large IRA and 401(k) accounts, the question is often whether the couple should consider paying all or a portion of their accounts to a bypass trust to benefit the surviving spouse. This takes the designated portion of the IRA or 401(k) proceeds out of the surviving spouse's taxable estate and helps with asset distribution, according to the article “Estate Planning for Married Couples' IRAs And 401(k)s” from Financial Advisor.
In 2013, the portability election became law. Portability allows the surviving spouse to use the unused federal estate tax exemption of the deceased spouse, thereby capturing not one but two estate tax exemptions. Why would a couple need a bypass trust?
The portability election does not remove appreciation in the value of the assets moved from the surviving spouse's taxable estate. A bypass trust removes all appreciation. An estate planning attorney will review your entire situation to determine the optimal path.
There are also situations when the portability election does not apply. One is if the surviving spouse remarries and then the new spouse predeceases them. With a bypass trust, remarriage does not matter (although estate planning documents do need to be updated).
The portability election also does not apply for federal generation-skipping transfer tax purposes. In other words, the amount that could have passed to an estate and generation-skipping transfer tax-exempt bypass trust, including appreciated value, could now be subject to federal transfer tax in the heir's estate.
If you use the portability election, those assets are subject to potential lawsuits against the surviving spouse and, if remarriage occurs, to any potential claims of a new spouse. A bypass trust provides better protection from lawsuits and claims.
Using the portability election may result in the first spouse to die losing the option to control where those assets go upon the death of the surviving spouse. A bypass trust provides more control for asset distribution.
The calculations for each situation must be considered, but the bypass trust can help reduce the taxable estate for children, after the surviving spouse has passed. It may also make sense for a portion of the 401(k) and other retirement proceeds to go to the bypass trust and another portion to the surviving spouse outright. The use of the beneficiary designation may allow for a full or partial disclaimer by the surviving spouse. However, the bypass trust could provide more flexibility than keeping assets in the original accounts.
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Reference: Financial Advisor (Jan. 7, 2022) “Estate Planning for Married Couples' IRAs And 401(k)s”