Exemption Trust

Unlocking the Secrets of Exemption Trusts: A Comprehensive Guide

Demystifying the Exemption Trust: What You Need to Know

An exemption trust is not just a legal term thrown around in estate planning circles—it's a strategic financial tool designed to shield a married couple's estate from the clutches of federal estate taxes. Picture this: an irrevocable trust stands as the guardian of the assets belonging to the first spouse to depart this world. Contrary to common belief, the surviving spouse doesn't directly inherit these assets. Instead, they find sanctuary within the confines of an exemption trust.

This irrevocable nature of the trust means it's set in stone; alterations or annulments can only occur with the blessing of the trust beneficiary. Why opt for an irrevocable trust, you ask? Well, it's a nifty way to siphon assets away from the taxable estate, thereby significantly reducing the estate's tax burden. From cash and investments to real estate and life insurance policies, an irrevocable trust can accommodate a diverse range of assets.

Peeling Back the Layers: How Does an Exemption Trust Operate?

An exemption trust, also known as a bypass trust or credit shelter trust, is a darling among affluent married couples venturing into the realm of estate planning. Its raison d'être? To substantially curb a couple's federal estate tax liability. The mechanism is rather intriguing—the surviving spouse finds themselves on the sidelines, watching as the assets of the deceased spouse find refuge in the trust.

When the second spouse eventually joins their partner in the afterlife, the trust's beneficiaries—typically the couple's offspring—inherit the assets. Here's the kicker: since the assets didn't pass directly to the surviving spouse, the beneficiaries dodge the estate tax bullet. But fear not, the surviving spouse isn't entirely left out in the cold. They retain certain access rights to the trust assets, allowing them to dip into the trust's income and principal for specified expenses like medical or educational bills.

The Impact of the 2017 Federal Tax Law on Exemption Trusts

The legislative landscape underwent a seismic shift in 2017, courtesy of Congress. The new tax law doubled the exemption threshold for estate taxes, catapulting it from just under $5.5 million per individual to a whopping $11.2 million for tax years spanning 2018 to 2025. What does this mean in layman's terms? If the total value of an individual's estate falls below this threshold, they're exempt from estate taxes. Even if the estate surpasses the $11.2 million mark, only the surplus amount is taxable.

A Real-world Glimpse: The Anatomy of an Exemption Trust

Let's delve into a hypothetical scenario featuring Priya and Krishnan, who have embraced the AB trust system for their exemption trust. Upon Priya's demise, her assets find a new home in Trust B, while any excess beyond the exemption threshold is channeled into Trust A to circumvent federal estate taxes. Krishnan can access the funds and their earnings during his lifetime. Upon his demise, Trust A's assets, up to the $11.2 million exemption limit, are bequeathed tax-free to his beneficiaries. Any remaining assets are subject to taxation. Conversely, the assets from Trust B sail through to the final beneficiary sans taxes.