The Bypass Trust: Using Disclaimers to Manage Large IRA Balances.

• Author: Foss, Mary Kay

Trying to fund a bypass trust can be problematic if clients only have a residence and a large retirement plan as their major assets.

On the surface, a residence isn't a good asset for a bypass trust for two reasons: A trust doesn't qualify for the exclusion under IRC Sec. 121; and--probably most importantly--the surviving spouse generally wants to own the family residence.

Likewise, an IRA (or qualified plan) isn't the best choice for a bypass trust because of income taxes imposed on the retirement benefits. When the spouse is named as beneficiary of the retirement plan and all other assets are in a revocable trust, the first spouse's unified credit exemption can go unused.

This fact pattern may be a problem now, but will be more prevalent when the unified credit exemption equivalent amount reaches $1 million and higher. Beginning next year, we will be faced with funding larger bypass trusts. At that dollar level, avoiding the use of retirement assets will be almost impossible.

Required Minimum Distributions

The IRS issued proposed regulations in January 2001 to assist taxpayers in determining Required Minimum Distributions (RMD). A major change in these new proposals is that the beneficiary of an IRA or qualified retirement plan is now determined as of Dec. 31 of the year after the plan participant or IRA owner passes away. The preamble to the new proposed regulations mentions that the timing of the beneficiary determination will allow for the use of disclaimers.

Disclaimers

Often disclaimers are used to take advantage of marital or charitable deductions or to correct some situation in the estate plan. A qualified disclaimer is not considered a gift from the disclaimant to the recipient of the disclaimed assets.

A qualified disclaimer is defined in IRC Sec. 2518 as an irrevocable and unqualified refusal to accept an interest in property, but only if:

(a) such refusal is in writing;

(b) such writing is received by the transferor of the interest, his or her legal representative, or the holder of the legal title to the property to which the interest relates not later than the date, which is nine months after the later of (i) the day on which the transfer creating the interest in such person is made, or (ii) the day on which such person attains age 21;

(c) such person has not accepted the interest or any of its benefits; and

(d) as a result of such refusal, the interest passes without any direction on the part of the person making the...