How To Maximize Your Clients Credit Shelter Trust
By Mark A. Teitelbaum
With the continued uncertainty surrounding the future of estate taxes, many advisors remain at a loss as to how they can best help their clients. One possible approach is to continue to work with clients who already have established and funded portions of their estate plans. In many cases, these clients can benefit from additional planning within their credit shelter trusts.
Even though assets in a credit shelter trust are available for use by the family, these assets often lie dormant for years. Why? Financial advisors have less desire to pay funds out of these trusts to the surviving spouse than from other sources–these assets already have been carved out of the survivors taxable estate.
Most advisors prefer that survivors spend down and gift other assets–ones exposed to estate taxes–before they ever access the funds in the credit shelter trust. As a result, the credit shelter trust assets are left to grow. They occasionally may benefit the family, but these assets are often overlooked and treated as a completed phase of a clients estate plan. Buying life insurance can provide an added focus to your clients already funded credit shelter trust.
If these assets were left in a standard portfolio, it is likely that over time, they would increase in value. Ultimately that value would pass to the trusts beneficiaries. It is also possible, however, that these assets would remain fixed in value or possibly even decline.
In light of this uncertain investment performance, life insurance provides two strong planning tools to help the beneficiaries. First, the death benefit potentially offers some immediate leverage for the funds in the trust. Additionally, with the proper design, life insurance death benefits have the ability to assure your client that his or her heirs will receive a certain minimum amount in the form of a death benefit.
Chart One illustrates how life insurance has the potential to increase the trust distributions to the beneficiaries. In this example, a credit shelter trust is funded with $1 million. Using a hypothetical investment return of 8%, with a 30% trust tax bracket, the heirs might receive $1,724,405 in 10 years and $2,973,571 in 20 years.
By comparison, if those same funds were used to purchase a hypothetical life insurance policy, the heirs might be able to receive a $4,250,000 death benefit.
By year 27, the investment portfolio used in this example reaches a crossover point and surpasses the $4,250,000 death benefit, with an after-tax value of $4,354,375.
Assuming this policy was purchased on the life of a 65-year-old widow or widower, the trustee will need to determine what is ultimately a better choice for the trust beneficiaries, after weighing the potential return, the time frame and the clients potential longevity. Here, the crossover point is projected to occur at the clients age 92.
Many factors go into the trustees decision. A key consideration is what the trustee might achieve, over the life of the trust, from an investment portfolio. The amount of life insurance coverage that the trustee might be able to purchase based on the age, health and ability to underwrite your client is another key consideration.
Just as the makeup of the trusts investment portfolio might be subject to many variations, so will the life insurance policy. You will need to work with the trustee on the appropriate design, the ability to purchase guarantees, or if your client is using a variable life policy, the makeup of subaccounts determined to be appropriate for a given client situation.
The trustee must also understand the need to make ongoing premium payments, although it is not uncommon for single premiums to be used in this type of client plan. Other trustees may opt to use only a portion of the trust assets for life insurance premiums.
The ideal client for this plan is one who has a funded credit shelter trust. While this may take some screening of existing clients, in some cases, these trusts may be relatively easy to locate after a review of client assets.