A credit shelter trust — sometimes referred to as a bypass trust or exemption trust — is an effective tool because it allows married couples to take full advantage of the amount that both spouses can pass estate tax-free. In addition, assets that pass into a credit shelter trust at the time of death of the first spouse can also be available for the use and benefit of the surviving spouse even though those assets will not be included in the surviving spouse’s estate, and thus, will be not counted for estate tax purposes at the time of their later death.
The credit shelter trust is usually funded at death, but the language for the trust needs to be put in place during your lifetime by including specific provisions in your will or revocable living trust. Since the purpose of the trust is to shelter assets in your name at the time of your death up to the amount you can pass estate tax-free, couples should divide their assets so that each spouse has at least up to the amount that he or she can pass estate tax-free. In other words, to shelter assets from estate tax in the credit shelter trust, you have to have assets in your name at the time of your death. Although the assets used to fund the credit shelter trust are considered part of the decedent’s estate, the applicable exclusion amount shelters these assets from the federal estate tax. Any assets above the exclusion amount can then be transferred to the surviving spouse outright or in a marital trust estate tax-free since spouses get an unlimited marital deduction. These “marital assets” will be included in the surviving spouse’s estate and will be subject to estate tax. Depending on the amount of the surviving spouse’s assets at the time of death and the amount of the exclusion at that time, estate taxes may or may not be due on those assets.
It is very important to use specific language and avoid certain other language when drafting the language for the credit shelter trust. Giving too much power or control over the trust assets could cause the inclusion of the trust assets in the surviving spouse’s estate. For that and other reasons, it is important to speak with your attorney and have him or her draft the language for the trust.
With or without portability, credit shelter trusts continue to be important and viable vehicles to minimize estate taxes, preserve wealth and provide for your spouse and other family members after your death. If you don’t properly title your assets to take advantage of its benefits, it’s like taking the time and effort to map out an evacuation route but leaving no gas in your car to use it. Yes, you need the language in place for a credit shelter trust in your will or revocable living trust, but if your assets are not owned in such a way to take advantage of it, all your planning could be for nothing.
William G. Lako Jr., CFP, is an executive in residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Lako is a certified financial planner. The MDJ will periodically publish columns from KSU business faculty.