This is another in a series of blogs on estate planning basics. Estate planning attorneys often use a “credit shelter trust” to preserve the estate tax exclusion of the first spouse to die. This strategy is not as important as it used to be at the federal level, but for the reasons listed below, is still an important planning tool for many families. In a credit shelter trust, assets up to the applicable exclusion amount are placed in the trust for the benefit of the surviving spouse for her lifetime, and then pass to designated beneficiaries free from estate tax upon the surviving spouse’s death.
The following are four reasons to consider using a credit shelter trust:
1. Provide for your spouse.
A credit shelter trust is the best of both worlds: it lets you provide for your spouse during his/her lifetime, and also lets you decide – today – what will happen to remainder of your estate assets. For example, the trust may prohibit the surviving spouse from giving the assets outright to a child who you know cannot handle that responsibility of a financial windfall. Also, if the surviving spouse remarries, the trust can help prevent your assets from going to children of the new marriage.
2. State exclusion amounts differ.
In most states, portability is not available for state estate tax exclusion, and the estate tax exemptions are less than the federal exemption. For example, the exclusion in CT is $2M and not portable, and the exclusion in MA is only $1M. This may seem like a lot of money if it is in your pocket, but is not beyond the reach of most families who own a home, have retirement savings, and/or own a business. A credit shelter trust helps maximize the exclusions available and decrease state estate taxes that may otherwise be payable.
3. Protect against asset growth.
Portability only carries over the exclusion amount in effect at the date of death. The credit shelter trust exempts assets and any growth on them from estate taxes. If the first spouse dies with a $2M exclusion (the current exclusion amount in CT), with portability the survivor will get exactly $2M of exclusion to cover assets in the survivor’s taxable estate. If those assets have grown to $10M, then the exclusion will not provide much protection against an estate tax. However, if $2M of assets are placed in the credit shelter trust and then grow to $10M, the trust assets may all be free from estate tax.
4. Protect assets.
Planning to use portability assumes the assets are going outright to the surviving spouse. If the assets are left in a credit shelter trust, that trust may be drafted to protect the assets from the surviving spouse’s creditors or the surviving spouse’s mismanagement or substance abuse.
Every situation is unique, but credit shelter trusts should be a basic estate planning consideration for many families.
Joe received his law degree from the University of North Carolina–Chapel Hill School of Law and his Accounting degree from the University of Rhode Island. He is admitted to practice law in Connecticut, Massachusetts, and Rhode Island, and he is a CPA. He is an Adjunct Professor and lecturer at the University level and has been a frequent speaker on business planning and legal matters.
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