What You Should Know About Credit Shelter Trusts
1. What is a Credit Shelter Trust?
A Credit Shelter Trust is an irrevocable trust established after the death of a married spouse for benefit of the surviving spouse. The name of the trust reflects its primary purpose of sheltering the deceased spouse’s available credit against the estate tax.
There is an unlimited estate tax deduction for property left outright to a surviving spouse. This eliminates any estate tax when the first spouse dies, but fails to protect this same property from estate tax when the surviving spouse dies. A common solution is use of a Credit Shelter Trust, which is designed to not qualify for the unlimited marital deduction. However, the estate plan is carefully restricted to cap the amount of property that may be transferred into the Credit Shelter Trust. This prevents taxation of assets beyond that which qualifies for the deceased spouse’s applicable estate tax exemption (currently $11.4 million, but subject to the political winds of change).
2. May the surviving spouse act as trustee?
Yes, the surviving spouse will usually serve as trustee of the Credit Shelter Trust. Depending on the trust document, the surviving spouse may also have the right to change the successor trustees.
3. What if the surviving spouse needs the money?
The Credit Shelter Trust is usually – but not always – drafted to permit the surviving spouse access to trust income and principal for needs related to health, education, support, and maintenance. If the surviving spouse is serving as trustee, this restriction is effectively not a restriction at all. After all, the surviving spouse would be the person to decide whether a distribution is permitted.
In some situations, such as when the deceased spouse has children from a prior marriage, the Credit Shelter Trust might further restrict the surviving spouse’s access to the trust assets. The trust could name an independent trustee or limit distributions to income only.
4. What if the surviving spouse gets remarried?
The trust document may be drafted to end the surviving spouse’s access to the trust if the surviving spouse remarries. Without this provision, the surviving spouse would have continued access to the trust even in the event of remarriage.
5. What happens when the surviving spouse dies?
When the surviving spouse dies, the remaining assets are distributed according to the terms of the trust (usually to the children). The trust document may be drafted to give the surviving spouse a power to change the beneficiaries. This is called a power of appointment.
All of the assets in the Credit Shelter Trust, including any appreciation in value during the surviving spouse’s lifetime, pass free of estate tax to the beneficiaries.
6. How is the Credit Shelter Trust funded?
The provisions for a Credit Shelter Trust are written into a will or living trust. There are essentially two ways the document may allocate property to the Credit Shelter Trust:
7. Which funding method is better?
For large estates – think above $11.4 million – the mandatory funding method is the better choice. However, the disclaimer funding method should be considered for modest estates. It rarely makes sense to fund a Credit Shelter Trust when doing so is not likely to save any taxes.
There are drawbacks of the disclaimer funding method that should also be considered. Research shows that surviving spouses have a natural instinct to resist funding of the Credit Shelter Trust because of a perceived lack of control. Also, funding a Credit Shelter Trust by disclaimer eliminates the possibility of letting the surviving spouse make changes to the ultimate beneficiaries.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.
A Credit Shelter Trust is an irrevocable trust established after the death of a married spouse for benefit of the surviving spouse. The name of the trust reflects its primary purpose of sheltering the deceased spouse’s available credit against the estate tax.
There is an unlimited estate tax deduction for property left outright to a surviving spouse. This eliminates any estate tax when the first spouse dies, but fails to protect this same property from estate tax when the surviving spouse dies. A common solution is use of a Credit Shelter Trust, which is designed to not qualify for the unlimited marital deduction. However, the estate plan is carefully restricted to cap the amount of property that may be transferred into the Credit Shelter Trust. This prevents taxation of assets beyond that which qualifies for the deceased spouse’s applicable estate tax exemption (currently $11.4 million, but subject to the political winds of change).
2. May the surviving spouse act as trustee?
Yes, the surviving spouse will usually serve as trustee of the Credit Shelter Trust. Depending on the trust document, the surviving spouse may also have the right to change the successor trustees.
3. What if the surviving spouse needs the money?
The Credit Shelter Trust is usually – but not always – drafted to permit the surviving spouse access to trust income and principal for needs related to health, education, support, and maintenance. If the surviving spouse is serving as trustee, this restriction is effectively not a restriction at all. After all, the surviving spouse would be the person to decide whether a distribution is permitted.
In some situations, such as when the deceased spouse has children from a prior marriage, the Credit Shelter Trust might further restrict the surviving spouse’s access to the trust assets. The trust could name an independent trustee or limit distributions to income only.
4. What if the surviving spouse gets remarried?
The trust document may be drafted to end the surviving spouse’s access to the trust if the surviving spouse remarries. Without this provision, the surviving spouse would have continued access to the trust even in the event of remarriage.
5. What happens when the surviving spouse dies?
When the surviving spouse dies, the remaining assets are distributed according to the terms of the trust (usually to the children). The trust document may be drafted to give the surviving spouse a power to change the beneficiaries. This is called a power of appointment.
All of the assets in the Credit Shelter Trust, including any appreciation in value during the surviving spouse’s lifetime, pass free of estate tax to the beneficiaries.
6. How is the Credit Shelter Trust funded?
The provisions for a Credit Shelter Trust are written into a will or living trust. There are essentially two ways the document may allocate property to the Credit Shelter Trust:
- By mathematical formula. The document might allocate as much of the deceased spouse’s property to the Credit Shelter Trust as possible without triggering an immediate estate tax. This is referred to as the mandatory funding method because the plan must be carried out.
- By disclaimer. An alternative method is the disclaimer funding method, which gives the surviving spouse the discretion whether to fund the Credit Shelter Trust or not. This might be appropriate if funding the trust would not be likely to save any taxes. This is referred to as the optional funding method.
7. Which funding method is better?
For large estates – think above $11.4 million – the mandatory funding method is the better choice. However, the disclaimer funding method should be considered for modest estates. It rarely makes sense to fund a Credit Shelter Trust when doing so is not likely to save any taxes.
There are drawbacks of the disclaimer funding method that should also be considered. Research shows that surviving spouses have a natural instinct to resist funding of the Credit Shelter Trust because of a perceived lack of control. Also, funding a Credit Shelter Trust by disclaimer eliminates the possibility of letting the surviving spouse make changes to the ultimate beneficiaries.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.