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Many wills need to be reviewed.

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In the past, many people tried to achieve a similar result – using both spouses’ exemptions – through the use of a trust, sometimes called a “bypass trust.” Typically, when the first spouse died, some of his or her assets (often a sum equal to the current exemption amount) went into a trust, and the rest was left directly to the surviving spouse. The trust might pay income and principal to support the spouse during his or her lifetime, after which the assets would go to children or other heirs. When the surviving spouse died, the trust property wasn’t included in his or her estate, and so it didn’t “count” toward the exemption amount.

The new law might make these kinds of bypass trusts unnecessary for some people – at least until the end of 2012.

You might want to consider the costs and benefits of eliminating such a trust from your will, or at least providing that the trust provisions won’t take effect unless the law changes again such that the trust becomes a good idea.

Some of the disadvantages of a bypass trust include:

  • The surviving spouse has less flexibility and access to the assets.
  • There are expenses in managing the trust, filing trust tax returns, and sometimes hiring an outside trustee.
  • If trust property is sold after the surviving spouse dies, the “basis” for capital gains tax purposes is its value at the time of the first spouse’s death – whereas without a trust, the basis would be the (presumably higher) value at the time of the second spouse’s death.

On the other hand, there are some powerful reasons to keep a bypass trust. For instance:

  • Assets in such a trust will be protected from a surviving spouse’s creditors, and from the actions of a future spouse if the surviving spouse remarries.
  • A spouse might want to put property in a trust to make sure that when the surviving spouse dies, the assets will go to the person’s children from a prior marriage.
  • A bypass trust can also reduce state estate taxes, as well as generation-skipping transfer taxes.
  • A bypass trust shields all future appreciation from estate taxes – even if the assets in the trust grow in value far beyond the amount of the first spouse’s exemption.

As an aside, if your old will says that the amount that will go into a bypass trust is equal to the exemption amount, you might want to review this in light of the fact that the exemption amount in 2011 and 2012 has been dramatically increased to $5 million. You might prefer to say that the trust assets will be the exemption amount or a certain dollar figure, whichever is less.

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