Bypass trust lets a couple achieve 2 important goals

Dollars & Sense

August 25, 2002|By Liz Pulliam Weston | Liz Pulliam Weston,SPECIAL TO THE SUN

You recently responded to a question from a reader who was confused about whether married couples were limited to a $1 million estate-tax exemption this year. Your answer, that each person gets a $1 million exemption, was technically correct, but you missed an opportunity to educate people about the possibility of wasting their exemption and the importance of bypass trusts.

Indeed, there is a danger that estate-tax exemptions can be wasted. Here's how it might play out:

Say a husband dies this year and leaves his estate to his wife. He's allowed to do that without incurring any estate taxes, because spouses are entitled to what's called an unlimited marital deduction.

But that money becomes part of his wife's estate. So if she hasn't spent it all by the time she dies, her estate could owe taxes on some or all of the bequest.

Let's say, instead, that the husband puts $1 million - the estate-tax limit - into a bypass trust. His wife can use the income from the trust and can even tap the principal in certain circumstances. But when she dies, the trust money goes to the secondary beneficiaries - usually the children - without incurring estate taxes. The money is never part of her estate, so it doesn't count against her $1 million exemption.

The husband also could avoid wasting his exemption by bequeathing the money directly to his kids, rather than putting it in trust for his wife. If she's well off without the money, that's sometimes the better course. That way, the kids don't have to wait for her to die to get their inheritance.

For many couples, however, the bypass trust is a well-tested method to make sure the surviving spouse is provided for while taking full advantage of the estate tax exemption.

We recently cashed in savings bonds totaling more than $8,000 that we had purchased to help my son pay for college. We put the proceeds in a money market account so he could cover personal expenses and his car payment. My son applied for a school loan and is using that money to pay his tuition and rent. Is the interest on these savings bonds subject to taxation?

The way you've got things set up, it is.

You can avoid taxation on Series EE savings bonds purchased after Dec. 31, 1989, but only if you use the money to pay tuition and fees. It can't be used to pay for rent, board, books or any other expenses. The cost of tuition and fees must be more than the value of the redeemed bonds to get the full exclusion. Otherwise, the benefit is reduced proportionately. (If your son's tuition and fees are just $4,000 this year, for example, you would escape tax on only half of the interest the bonds earned.)

There are other restrictions as well. For example, you or another parent must be the bond owner, and you should be the one paying the tuition and fees. If the bonds were in your son's name, they're not eligible for tax-free treatment. The bonds also must be redeemed in the same year the bond owner pays the expenses.

In addition, there are income limitations. You can exclude all the interest from taxation only if your modified adjusted gross income was $86,400 or less if you filed jointly. (The limit is $57,600 for single filers.)

You can learn more about tax-free treatment of savings bonds when used for educational expenses on the Bureau of the Public Debt's Web site, www.savingsbonds.gov.

You often emphasize the importance of checking your credit report once a year. How can you do this without paying fees?

Generally, you can't, unless you recently have been turned down for credit or live in one of six states that require you be given one free copy a year. Those states are Maryland, Colorado, Georgia, Massachusetts, New Jersey and Vermont.

Otherwise, you're usually stuck paying the $8 to $9 fee. You can cut down on the cost by checking your report at just one of the three major bureaus, rather than buying from all three.

The bureaus share information, so most of what's shown on one report will be reflected on the other two.

Liz Pulliam Weston is a columnist for the Los Angeles Times, a Tribune Publishing newspaper.

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