Individuals can pass up to $13.99M (2025) to heirs free of gift, estate, or generation-skipping transfer (GST) tax. Excess transfers are taxed at a rate of 40%, and there is the possibility that the exemption amount will decrease to the prior law’s exemption of $5M (indexed for inflation). Most individuals will not have estates subject to estate tax. Since 2011, a deceased spouse’s unused gift and estate tax exclusion has been “portable” to a surviving spouse with the filing of a timely estate tax return. While this estate tax law allows married couples to transfer up to $27.22M to heirs more simply, considering their combined gift and estate tax exclusions, it might also mean that their bypass trust, while still functional, may not necessarily be their best option and may seem like an outdated technique.

A Closer Look at the Bypass Trust

Most married couples want the surviving spouse to have access to the couple’s full wealth for their support during widowhood. Yet before portability, if a deceased spouse left all their assets to their spouse, the couple’s full wealth would be included in the surviving spouse’s estate, but the surviving spouse would only have their own estate tax exclusion to shield the married couple’s combined wealth from estate tax. Therefore, prior to 2011, the only way for a married couple to provide for a spouse and use both spouses’ estate tax exclusions was to fund a bypass trust at the death of the first spouse. The bypass trust would be funded with as much of the deceased spouse’s property that could pass free of estate tax using their exclusion and then pass tax-free to the couple’s heirs following the surviving spouse’s death. Thus, the bypass trust would financially provide for the surviving spouse during their life and allow both spouses to use their combined exclusion to maximize the inheritance passed to heirs free of the estate tax.

With portability, you may not need the bypass trust to use both spouses’ exclusions, but you might want to keep the bypass trust in your estate plan given the following potential benefits of a bypass trust:

Protects the First Spouse to Die’s Testamentary Intentions

If assets are left directly to a surviving spouse, the surviving spouse might change the trust terms. The bypass trust is irrevocable on the first spouse’s death, locking in the first spouse to die’s intentions which might be particularly important with second marriages or blended families where there’s a concern that the survivor might change beneficiaries.

Provides the Surviving Spouse Some Creditor Protection

The assets included in the bypass trust should provide the spouse with some level of creditor protection as the spouse would be a potential beneficiary of the trust but not actually own the assets in the bypass trust.

Protects Growth on the First Spouse To Die’s Property Excluded From Transfer Tax 

While the estate exclusion is indexed for inflation, any unused estate exclusion a surviving spouse takes from the deceased spouse is not adjusted for inflation and is locked into the exclusion amount on the deceased spouse’s date of death. Where there’s a chance that the total combined estate at the surviving spouse’s death might exceed $13.99M (2025), the couple may want to retain the bypass trust so that the appreciation on the first spouse to die’s property held in a bypass trust passes to heirs free of the estate tax.

Ensures that the First Spouse to Die’s GST Tax Exemption Can Be Used to Exclude Property from GST Tax

The generation-skipping transfer tax taxes assets that skip a generation, such as a gift by a grandparent to a grandchild. If the combined amount you might leave to skip-persons such as grandchildren is likely to be more than the GST exemption, you might want to consider retaining a bypass trust to ensure that the first spouse to die’s GST tax exemption can shield assets passing to grandchildren from this tax as the GST tax exemption is not portable to a surviving spouse. [Certain marital trusts may also ensure the use of both spouses’ GST tax exemption.]

Ensures that the First Spouse To Die’s Credit Against State Estate Tax Can Be Used

If you live in a state that has a state estate tax, you might want to use the bypass trust to be sure that each spouse can exempt as much of their estate as possible from the state estate tax, as state estate tax exemptions are generally not portable under current state laws.

If you don’t truly need the bypass trust, meet with your attorney to revise your estate plan, given the potential downsides to the bypass trust:

A Bypass Trust Requires More Significant Administration

The need to divide assets at the first death and the associated costs with administering separate trusts for the surviving spouse’s lifetime, including the preparation of a separate income tax return/K1s for beneficiaries, is typically more costly than leaving all assets to a spouse and relying on portability to use both spouses’ exclusion.

Assets in a Bypass Trust Do Not Receive a Step Up In Income Tax Basis at the Surviving Spouse’s Death

Assets transferred to a bypass trust at the first spouse’s death receive an adjustment (typically, a step-up) on an income tax basis, but not again on the death of the surviving spouse. If assets are instead left to the surviving spouse outright or via a marital trust relying on portability to use both spouse’s exclusion, the surviving spouse will receive an income tax basis adjustment on the death of the first spouse, and the assets would also remain part of the surviving spouse’s estate where they could receive another step up in income tax basis at their death. Without the bypass trust, your heirs might receive a higher income tax basis and pay less tax on a sale of the assets after the surviving spouse’s death.

Assets in a Bypass Trust Might Be Subject to Higher Income Tax

A bypass trust’s undistributed income (i.e., income not distributed out to beneficiaries) is taxed at compressed trust income tax rates which subject any undistributed income over $15,650 (2025) to be subject to the top marginal income tax rate of 35% and potentially subject to the additional 3.8% Medicare surtax on net investment income.

Keep the Bypass Trust? 

many married couples will keep their existing bypass trust even if they don’t need it for tax purposes for the same reason they might keep an older model cell phone: it still works and provides some desired benefits. Others will consider losing the bypass trust if they anticipate having less than $10M (assuming the possible return in 2027 to the $5M per person estate exemption indexed for inflation) to leave to heirs to save the surviving spouse the hassle of administering separate trusts after the first death. This also potentially reduces the income tax heirs might face on the later sale of inherited assets, given the potential for a step up in income tax basis at the survivor’s death. But even couples likely to leave less than $10M to heirs might keep the bypass trust if they (1) might leave more than $5M to a trust that would eventually pass to grandchildren (no portability of exemption against Generation-Skipping Transfer Tax, though a certain marital trust may be considered); (2) don’t live in a state that has abolished the state estate tax and will have more assets than the state exemption (typically no state-level portability of exemption against state estate tax); or (3) don’t want to create a new trust yet want to lock in the first spouse to die’s beneficiaries and provide creditor protection for a spouse.

Next Steps

We recommend you review your estate plan with your attorney every five years or upon any major life change. Even if the potential benefits associated with losing the bypass trust don’t spur you to take action today, a review of the bypass trust’s relevance is warranted the next time you review your estate plan. Your attorney can recommend your best trust options, including:

•  Keeping the bypass trust;
• Paring down to a single trust structure;
• Providing the survivor a choice at the first death to keep a single trust structure or fund a bypass trust (Disclaimer Trust); or
• Exchanging the bypass trust for a marital trust where a bypass trust isn’t needed for tax reasons but is desirable to lock in the first spouse to die’s beneficiary plans, preserve the GST tax exemption and provide creditor protection to a spouse. A marital trust can provide these same non-tax benefits yet allow for a potential income tax-basis step up at the surviving spouse’s death.

If you could benefit from a conversation with our advisory team, we would be happy to provide a complimentary consultation.    

Important Disclosure: Beacon Pointe Advisors does not offer legal or tax advice. Please consult with the appropriate tax or legal professional regarding your circumstances. This information is not intended and should not be relied upon as individualized tax, legal, fiduciary, or investment advice. Only a tax or legal professional may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement any design discussed herein. Nothing herein should be relied upon as personalized investment advice, nor should it be considered an individualized recommendation, offer, or solicitation for the purchase or sale of any security or to adopt a specific investment strategy. An investor should consult with their financial professional before making any investment decisions. Beacon Pointe is not responsible for errors or omissions in the material on third-party websites and does not necessarily approve or endorse the information provided.