A spousal bypass trust is a special legal mechanism to avoid some of the inheritance tax that would apply when one spouse dies and their benefits pass to their surviving spouse. This type of trust lets individuals take advantage of a pension or annuity that has survivor’s benefits without triggering inheritance tax on those benefits.
How a spousal bypass trust works
A spousal bypass trust works by becoming the beneficiary of the spouse who passes away. Then, the trust pays the benefits out to the surviving spouse via the trustees. The process for setting up such a trust can be somewhat complex, and there are multiple ways to do it.
When to use this type of trust
Considering the benefits of such a trust is an important part of the estate planning process. These trusts are useful if the deceased spouse had a pension or annuity that contained a lump-sum death benefit. Normally, these payments would be subject to an inheritance tax, but by placing these lump-sum benefits into a trust and then having the trust pay the spouse, this tax can be avoided. The specific rules for when and how the benefits can be paid out depending on the type of trust.
Inheritance taxes can be substantial, so reducing their impact can be a major benefit to the heirs of the deceased. Survivor benefits are meant to support the surviving spouse, so a spousal bypass trust can translate directly into a large increase in the effective size of this benefit. It is a somewhat advanced legal technique but a useful one for preserving the value of the lump-sum benefit and maintaining its intended use.