Lawrence B. Keller, CFP, CLU, ChFC

Q: My spouse and I have grown children from previous marriages. We don't want to make distributions to our children or charities until after we are both deceased, but we do want to minimize the amount of taxes on our combined estate. Will a bypass trust help us with these objectives?

  Yes. A bypass trust is a tool married couples use to minimize the estate tax that will be due on their combined estates. It gives the surviving spouse the ability to benefit from their combined wealth until he or she is deceased. On the death of the first spouse, assets held in that spouse's name individually are directed to fund the bypass trust up to an amount equal to his or her federal applicable exclusion amount, which currently is approximately $5 million for an individual. The remaining assets of the first spouse to die can be transferred either outright to the surviving spouse or into a marital (or "Q-TIP") trust for the benefit of the surviving spouse.  

For the bypass trust to work properly, it is important for you and your spouse to ensure that your assets are titled in individual names and not held jointly or in trust for the survivor. That way, the assets of the first of you to pass away would be available to fund the bypass trust. The trust could provide for income distributions to the surviving spouse and allow or restrict principal distributions to the surviving spouse. Then, on the passing of the second spouse, the bypass trust would terminate and assets would be distributed according to your wishes and intentions. A bypass type of trust generally is created on the death of the first spouse and is directed to be created in the will or other testamentary document of each spouse. 

Answers to our readers' questions were provided by Lawrence B. Keller, CFP, CJU, ChFC, founder of Physician Financial Services in Woodbury, New York, and Michael J. Hausman, JD, partner with the law firm Karol Hausman & Sosnik P.C. in Garden City, New York. Send your money management questions to 

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This tool can help married couples make distributions to their children and charities posthumously without giving more than necessary to the government.

Use bypass trust to minimize estate taxes, postpone distributions

Q: I established an irrevocable life insurance trust (ILIT) several years ago to own and be the beneficiary of my life insurance policy. But after market losses and an increase in the estate tax exemption, I'm not sure that the ILIT is such a good idea. Can the trustee of the trust transfer the assets, including ownership of the policy, out of the trust so that it has no assets?  

Collapsing or amending the trust would be difficult, because the trustee's fiduciary obligation is to preserve the trust's property for the beneficiaries. But you can consider other options: 

The trustee can "sell" the policy from the trust for its fair market value. Generally, fair market value is similar to the cash reserve value of a policy. Under some circumstances, however, the values could be different. For example, the trust policy has $100,000 of cash reserve value. The trustee may be able to sell the policy back to you for $100,000, which could be cash or other property having the same value. The trust would then be funded with $100,000 of cash or property. Thereafter, you would own the policy, and only the cash in the trust would be subject to the terms of the trust. 

The trustee may have the right to distribute trust principal to one or more of the trust beneficiaries during the grantor's lifetime. So if the trust distributes the policy to a beneficiary, then the beneficiary could, in turn, gift the policy back to you. 

You can stop paying premiums on the policy, or stop making gifts to the trust so that the trustee does not have funds to pay premiums. If the trust has no other property and the policy lapses, the trust terminates. Depending on the trust terms and local law, however, the trustee may be obligated to exercise any policy rights that may continue coverage or ask trust beneficiaries to make contributions. 

Which solution you choose should depend on trust provisions, state law, and your ultimate objectives. Consult an estate-planning attorney to determine your best course of action. But before you consider terminating an ILIT or removing the insurance from the ILIT, make sure that you consult with your insurance agent, financial planner, and legal and tax advisers to ensure that this is the right course of action for you and to minimize potential adverse consequences. 

Found yourself with a trust that doesn't work well in the market? Learn how you can change the situation.

Look for alternatives to amending trust

 I've been unable to find a residency training position in my desired specialty in the United States and am considering relocating to Germany for this training. Would I still have to file tax returns in the United States while I am away? Would I have any tax obligations for money I make while in Germany?

 If you are a U.S. citizen or resident alien, then you are required to report your worldwide income on your federal income tax returns. If you are living abroad, however, then the first $87,600 in income is not taxed. If your salary will be less than that amount, then no taxes will need to be paid in the United States, but you still will be required to file an income tax return each year. 

The IRS tax form to use to report your foreign source income is Form 2555.   

Whether you are taxed while in Germany depends on the German tax rules and whether a tax treaty exists between the United States and Germany that excludes from German taxes the income you earn abroad.  

Answers to our readers’ questions were provided by Lawrence B. Keller, CFP, CLU, ChFC, of Physician Financial Services in Woodbury, New York.

Disability insurance, disability policy cost and tax obligations while training overseas are all addressed

Tax obligations while training overseas

 Several male colleagues are paying much less for their disability insurance than I am. We all are earning the same income, are about the same age, and are in the same specialty. Is this normally the case for female physicians like me?

 Yes, it is the case. Although, actuarially, women are better risks for life insurance compared with men, it is the opposite for disability insurance. Although women live longer, they don't necessarily live more healthfully, mainly due to complications of pregnancy and stress. 

For example, Dr. Jones, a 35-year-old female dermatologist in New York, purchased her policy from a well-known insurance company. Assuming a monthly benefit of $5,000, a 90-day waiting period, benefits payable to age 65, a residual disability rider. and a 6 percent cost of living adjustment rider, her fixed annual premium would be $3,743. That same policy, with a unisex rate and "multi-life" discount, would cost $2,120, however, an annual savings of $1,623, or approximately 43 percent off the normal rates for women.   

Many hospitals and medical associations have existing programs that you can access without having to take the time and effort to establish something on your own. Be sure to ask the insurance agent or financial planner with whom you are dealing about the availability of such programs, or look for an agent or planner who specializes in working with physicians, because he or she most likely would have access to several of them.  

Author | Lawrence B. Keller, CFP, CLU, ChFC

Articles

Use bypass trust to minimize estate taxes, postpone distributions

Look for alternatives to amending trust

Tax obligations while training overseas

Disability policy cost for women versus men