We Trust and Will trial attorneys just love the confusing world of Bypass Trusts. What began as a simple way of saving money on estate tax has become a sword and shield of warring family members.
In its simplest form, a Bypass Trust is created after one spouse dies. The Bypass Trust is supposed to receive the deceased spouse’s share of the estate. The Trust is irrevocable, and for that reason not included in the surviving spouse’s estate at the time of his or her death. This means that any assets transferred to a Bypass Trust are exempt from estate taxes in the future—a real win from a tax perspective.
But that’s where the problems can start. Since the Bypass Trust is irrevocable, it cannot be changed, amended, or terminated by the surviving spouse. Further, in most Trust where a Bypass Trust is specified, its creation and funding with assets in mandatory—there’s no way around it. And while a Bypass Trust can allow income and principal distributions to the surviving spouse, they can be severely limited on what can be distributed depending on how the Trust is drafted.
First, the mandatory requirement to create and fund the Bypass Trust can be a problem when a surviving spouse ignores this provision or fails to follow it for any reason. Since its funding is mandatory, a disgruntled beneficiary can sue the surviving spouse at nearly any time to enforce the creation and funding of the Bypass Trust. This can even be done after the surviving spouse dies, in an attempt to recoup the assets lost to the Bypass Trust.
Second, the distribution provisions to the surviving spouse form the Bypass Trust can be argued over. If the survivor is entitled to income and principal for support and health, who makes that determination? Who’s to say when the need arises or whether the survivor really needs a distribution or can simply use his or her own assets. These can be tricky issues to navigate when children of the deceased spouse are hostile to the surviving spouse.
Third, since the Bypass Trust is irrevocable, the survivor cannot simply use the Trust assets for any reason or give them away. There are legal restriction placed over the money to protect the named beneficiaries.
If you don’t do things properly with a Bypass Trust, there will be a nasty lawsuit in your future if the children choose to fight.
Bypass Trusts work great to protect the rights of the named beneficiaries (usually the children of the deceased spouse). And Bypass Trusts can be a handy tool to recoup lost assets when a survivor fails to follow the Trust terms. The question is, will you be hurt or helped by a mandatory Bypass Trust? It depends on which side of the question you fall.
So the next time you look at your Trust, find out if you have a mandatory Bypass Trust provision. If you do, follow it.
