A Bypass Trust, also known as a Credit Shelter Trust, is an estate planning tool used by married couples to reduce or eliminate federal estate taxes.
It is designed to ensure that both spouses fully use their estate tax exemptions — instead of wasting one.
Although estate tax laws have changed in recent years, bypass trusts remain an important strategy in certain situations.
How Does a Bypass Trust Work?
A Bypass Trust is typically created as part of a married couple’s estate plan.
When the first spouse passes away:
- A portion of the estate — up to the federal estate tax exemption amount — is placed into the bypass trust.
- The surviving spouse can receive income (and sometimes limited principal) from the trust.
- The assets in the bypass trust are not included in the surviving spouse’s taxable estate.
- When the surviving spouse later passes away, the remaining trust assets go to the chosen beneficiaries (often children).
Because the assets “bypass” the surviving spouse’s estate for tax purposes, they avoid estate taxation at the second death.
Why Was the Bypass Trust So Important?
Before “portability” became part of federal estate tax law, if a spouse died without using their exemption, it was lost forever.
The bypass trust ensured:
- The first spouse’s exemption was preserved.
- Both exemptions could be used.
- Estate taxes were minimized for larger estates.
Do Bypass Trusts Still Matter Today?
Today, federal law allows portability — meaning a surviving spouse can use the deceased spouse’s unused exemption.
However, bypass trusts may still be valuable when:
- The estate exceeds federal or state estate tax thresholds.
- The couple lives in a state with its own estate tax.
- Asset protection for the surviving spouse is important.
- There are blended family concerns.
- There is concern about future reductions in the estate tax exemption.
Estate tax laws can change, and planning flexibility remains important.
What Does the Surviving Spouse Receive?
The surviving spouse typically:
- Receives all income from the trust.
- May receive principal for health, education, maintenance, or support.
- Does not control ultimate distribution after death.
The first spouse maintains control over where the remaining assets go — even after the surviving spouse passes away.
Advantages of a Bypass Trust
Estate Tax Protection
Removes assets from the surviving spouse’s taxable estate.
Asset Protection
Trust assets may be protected from:
- Creditors
- Lawsuits
- Potential remarriage issues
Control Over Final Beneficiaries
Ensures children from a prior marriage are protected.
Appreciation Outside the Estate
Future growth of trust assets avoids estate taxation at the second death.
Potential Drawbacks
- Additional administrative complexity
- Separate tax filings for the trust
- Less flexibility compared to portability-only planning
- May be unnecessary for modest estates
Proper drafting is critical to balance tax planning with flexibility.
Example Scenario
Imagine a married couple with a combined estate that may exceed estate tax limits.
When the first spouse dies:
- $5 million is placed into a bypass trust.
- The surviving spouse receives income from the trust.
- The remaining estate passes outright to the spouse.
When the surviving spouse later passes away:
- The bypass trust assets are not included in their taxable estate.
- The assets pass directly to the children.
This can significantly reduce estate tax exposure.
The Bottom Line
A Bypass Trust (Credit Shelter Trust) is a time-tested estate planning strategy that can preserve estate tax exemptions, protect assets, and ensure control over final distributions.
While not every couple needs one today, bypass trusts remain highly effective in larger estates, blended families, and states with estate taxes.
Because estate tax laws change and planning strategies must be tailored to your specific situation, discussing whether a bypass trust fits your estate plan is an important step.
