Most parents and grandparents have a desire to, upon their deaths, pass along the estates they have built to their loved ones. This is a good and noble desire. Unfortunately, there are estate taxes, which can significantly reduce the amount of assets available to beneficiaries.
Thankfully, there are ways to protect your assets so that you can distribute the maximum amount available to those you love.
One of those solutions is a Credit Shelter Trust. Or, if you’re looking for other solutions, check out our complete guide on trusts.
What is a Credit Shelter Trust?
A Credit Shelter Trust is a type of irrevocable trust that is designed to protect a married couple’s estate from the potential estate taxes that could be incurred upon their death. This type of trust allows the spouse who survives the deceased to use the assets in the trust without having to pay taxes on them.
The trust is created when a spouse dies and is funded by some or all of the estate of the deceased spouse. The amount that goes into the trust is specified in the initial trust agreement. The trust itself is managed by a specified trustee. Because of this, the assets in the trust are not considered part of the surviving spouse’s estate and thus aren’t subject to estate taxes. These assets can be used to provide income, pay bills, etc.
When the surviving spouse passes away, the funds in the Credit Shelter Trust are then passed to the specified beneficiaries. Credit Shelter Trusts are also called AB Trusts or Bypass Trusts.
What is the Purpose of a Credit Shelter Trust?
Credit Shelter Trusts are most often used by wealthy couples who want to ensure that their heirs receive the maximum inheritance possible. By sheltering some of the couple’s assets in a trust, they can minimize the amount of taxes paid on their estate and pass more of their wealth on to their loved ones.
Additionally, using a Credit Shelter Trust allows spouses to be confident that, should one die, the other will have the maximum amount of assets at their disposal. They don’t have to worry about estate taxes eroding a significant portion of their estate, leaving the surviving spouse with significantly diminished assets. This can give peace of mind to each spouse, knowing that even when they aren’t present, their beloved spouse is being properly cared for.
The Benefits of a Credit Shelter Trust
There are numerous benefits that come with establishing a Credit Shelter Trust.
Protection of assets
By placing assets in a Credit Shelter Trust, you are effectively sheltering them from estate taxes. Additionally, you are placing them out of reach of creditors, as well as those who could potentially misuse your assets others, like unscrupulous children.
Freedom in distributing assets
Asset distribution can become complicated, particularly for blended families. For example, one spouse may want to pass on their assets to specific beneficiaries, such as their biological children, rather than divide up their assets equally among all family members. As you might imagine, this has the potential to cause divisions and quarrels among the family members. Using a CST can mitigate these challenges and make the entire process much smoother.
The CST can include provisions that give the surviving spouse a limited power of appointment. They can distribute assets to beneficiaries who meet certain criteria, even if they didn’t meet those criteria upon the creation of the trust. For example, if one of the beneficiaries sustains a significant injury and needs extensive medical care, the surviving spouse could establish a new trust to help meet the needs of the beneficiary.
Avoid taxes on appreciating assets
Assets that increase in value, such as stock portfolios or real estate, would normally be taxed at their current value upon the death first spouse. However, as part of a CST, they can appreciate in value while the surviving spouse is alive and then be passed to the beneficiaries tax-free.
Frequently Asked Questions (FAQs) about Credit Shelter Trusts
Can a Credit Shelter Trust be modified?
In certain circumstances, when one spouse has died but the other is still alive, a CST can be altered, or even terminated. Depending on the specifications of the trust agreement, it may be altered by just the trustee, by the trustee and the beneficiaries, or by taking legal action on the matter.
What is a Revocable Credit Shelter Trust?
A Revokable Credit Shelter Trust is one in which the grantor (creator of the trust) has retained the right to revoke or change the trust agreement during their lifetime. Once the grantor dies, the trust becomes irrevocable. This arrangement gives the grantor flexibility to alter the trust should new circumstances arise that weren’t taken into consideration when the trust was initially drawn up.
What are the tax implications with a Credit Shelter Trust?
Credit Shelter Trusts are designed to help couples utilize every possible estate tax exemption, including the Generation-Skipping Transfer Tax exemption. Normally, when there is a transfer of assets to an individual that is 37.5 years younger (e.g. grandparents to grandchildren) than the donor, that transfer is subject to estate taxes. However, when those assets are transferred via a Credit Shelter Trust, they are exempt from taxes up to a certain threshold.
Most beneficiaries never hit that threshold, given that in 2020 it was set at $11.58 million per individual or $23.16 million for couples.
Is a Credit Shelter Trust right for you? If you have a significant amount of assets that you want to first pass on to your spouse and then to additional beneficiaries, it may be the solution you’re looking for. It gives you peace of mind, knowing that your assets will be protected from unnecessary taxes, your loved ones will be cared for, and that you’ll leave a legacy for years to come.
If you’re looking to set up a Credit Shelter Trust, the first step would be to find a local attorney who can walk you through the process. Or, if you are looking to do a bit of research, you can look at banks like Bank of America or create a simple and affordable trust through an online provider like Trust & Will.