Bypass Trust | Estate Tax Planning with Life Insurance

A bypass trust — also called a credit shelter trust or B trust — is an estate planning tool that allows married couples to make full use of both spouses’ estate tax exemptions. Without a bypass trust, a surviving spouse who inherits everything outright may end up with a taxable estate that exceeds the single exemption amount.

How a Bypass Trust Works

When the first spouse dies, assets up to the federal estate tax exemption amount are placed into the bypass trust instead of passing directly to the surviving spouse. The surviving spouse can benefit from those assets during their lifetime — receiving income and, in some cases, principal — but the assets are not included in their taxable estate when they die.

The result: both spouses’ exemptions are used, potentially sheltering twice the exemption amount from estate taxes.

The Role of Life Insurance

Life insurance is frequently used in conjunction with bypass trusts to:

• Provide liquidity to fund the trust at the first death
• Equalize inheritances between heirs
• Replace assets that pass into the trust and away from the surviving spouse’s direct control
• Pay estate taxes so that illiquid assets (real estate, business interests) don’t have to be sold

A survivorship (second-to-die) life insurance policy is often the most cost-effective solution — it insures both spouses and pays out only after both have died, which is precisely when estate taxes are due.