Family Trust

A family trust, also known as a "B Trust", “credit shelter” trust, or a “Bypass Trust”, provides a husband and wife an opportunity to pass money or assets on to children in the most estate tax-efficient way. When the first of a husband and wife dies, it is common to leave all assets to the survivor. However, this prohibits the deceased person to use his or her Federal or State estate tax exemption. At the same time, it puts all of the assets into the name of the survivor. When the surviving spouse dies, only one estate tax exemption is available.

By placing assets into a family trust upon the death of the first spouse to die, assets and income are still available to the surviving spouse, but the exemption amount of the deceased spouse (currently $3.5 million) can be passed on to children without ever subjecting those assets to federal estate taxes. Furthermore, upon the death of the surviving spouse, none of those assets are included in the surviving spouse’s estate. The surviving spouse still has his or her exemption. Up to $7 million of assets can pass to the next generation federal estate tax free if the family trust is properly utilized.

The advantages discussed above, can be summarized as follows:

  • First Spouse Uses Exemption (current maximum of $3.5 million).
  • Surviving Spouse Has Small Amount of Assets Subject to Federal Estate Tax.
  • Significant Access to Income and Principal to Surviving Spouse. (The spouse may receive all income, principal for certain life-sustaining needs, and the right to withdraw up to 5% of the value of the trust annually, on demand).
  • Surviving Spouse May Gift Assets to the Children from the Family Trust.
  • Surviving Spouse May Determine How Trust is Disbursed at Death (limited by certain IRS rules).
  • Opportunities for Postmortem Estate Planning. (Funding the trust with assets that have the potential to appreciate).

A family trust is one of the most commonly used, most versatile, and most effective estate planning tools. But for the uninitiated, it's also the source of much unnecessary confusion and concern. Here is an example of how it works:

Martha dies in 2009. Under the terms of her will, she leaves $3.5 million in a trust for the benefit of her husband, George. He will receive all of the income from the trust for the rest of his life. Assuming that the assets are invested to achieve a net return (exclusive of capital gains) of 4%, George will get about $140,000 in income from the trust each year.

In addition, George may withdraw the greater of $5,000 or 5% of the value of the trust assets each year. Assuming the trust either stays at $3.5 million or (more likely) grows over time, George may withdraw as much as $175,000 of principal from the trust each year. Also, if George needs additional funds, he may ask the trustee for more based on certain human needs.

George may also make gifts from the trust to his children, because he has a "special power of appointment" to do so, under the terms of Martha's will. (Powers of appointment are technical in nature, and require careful drafting by an estate planning attorney.) At his death, George may also specify, in his will, who will receive the assets of the trust.

Thus, it's obvious that George has significant access to the trust, and it will not be taxed in his estate when he dies, regardless of how much it has grown.