posted on January 31st 2014 in Austin CFP Team Posts & Your Family with 0 Comments /

Many revocable trusts contain by-pass planning. This type of plan captures the assets owned by, in whole or part, a deceased spouse in a trust for the survivor instead of simply giving the survivor the assets outright.

One primary purpose of this type of planning is to preserve the federal and tax exemptions that would otherwise be forfeited. These trusts are referred to in many ways, including Family Trusts, Credit Shelter Trusts, and Residuary Trusts.

These trusts incur millions of dollars each year complying with tax and other reporting requirements and often result in a higher income tax bill than if the spouse owned the assets outright.

Now that only an estimated .14 percent of estates will owe a tax, many couples and surviving spouses are asking the questions, “Should I eliminate this type of planning in my revocable trust?Can an existing Family Trust be terminated?”

Most states allow a trust to terminate if “the material purpose of the trust no longer exists.” For many families, the only purpose of the by-pass trust is to reduce or eliminate federal estate taxes. If the surviving spouse has an estate of less than $5,340,000, even after adding the amount of the by-pass trust, the trust may no longer serving its original purpose.

Should it be terminated?

Arguments for Termination or Elimination
If all parties agree, including the trustee and the current and future beneficiaries, the trust could be terminated before the death of the spouse. The advantages include:

  • There will be no annual tax return to file;
  • The trustee will no longer be obligated to comply with administrative rules such as sending notices;
  • The assets will get a step-up in basis at the spouse’s death (assets in a by-pass trust are not stepped up).

Reasons Not To Terminate
The reasons to terminate are compelling but there are also solid reasons not to terminate a by-pass trust, including:

  • The spouse could decide to give the assets to someone else;
  • If the spouse is married (or later remarries), these assets are subject to the marital rights of the new spouse if not waived in writing;
  • A typical by-pass trust is creditor protected; and
  • If all of the assets are distributed to the surviving spouse, the other trust beneficiaries (current and/or future) may be making a taxable gift to the spouse.

Conclusion
Dumping the Family Trust may work for some families and may save both administrative costs and income taxes, but all of the factors should be taken into consideration before doing so. You should consult with an advisor for more information.

about the author: Kermit Johns

kermit640x640Kermit Johns is a Financial Planner who has extensive experience addressing the financial goals and the issues that same-sex couples face by offering his knowledge of comprehensive investments, and tax and estate planning. Kermit has served as an executive director in Corporate Tax with Time Warner Inc. and as a corporate tax manager for the Hertz Corporation. Kermit previously served as a managing director of his own registered investment advisory, Johns & Wilkinson LLC, in New York and Austin, where he successfully developed business relationships with individuals and couples, not-for-profit agencies, and foundations. Kermit was an FINRA-Licensed Securities Advisor and principal since 1997.

Learn more and/or Contact Kermit Johns

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