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.

In some cases, your clients may have done advanced planning and funded these trusts while both individuals are alive. It may make sense to purchase second-to-die coverage in these trusts.

More likely, however, these trusts have been, or will be, funded at the death of the first spouse. In either case, the better the health of the client, the better leverage received through the life insurance.

Most client issues about using a credit shelter trust to purchase life insurance center on control or loss of access to trust funds. Clearly, the best clients for these arrangements are ones who will not need trust funds for living expenses. Nevertheless, clients may have some other questions.

Clients are often concerned that the purchase of life insurance will block these assets from use in case of an emergency. But the life insurance contract is a trust asset, just like any other. To the extent the trust allows survivor spouses and other beneficiaries access to trust assets, a trustee can use the life insurance policy cash values.

This is usually not recommended because access to policy cash values will affect the death benefit ultimately paid to the heirs. But this is also the case with any other trust distribution; removing funds from such a trust will increase a clients estate and reduce trust benefits.

Clients and trustees will often ask if the purchase of life insurance is the best use of trust assets. It is important to remember that no single planning approach is ideal for every situation. The only way to determine if the intended approach makes sense for a credit shelter trust and the beneficiaries is to do an analysis similar to the one shown in Chart One.

There are also some legal issues that need to be considered before going forward with this strategy. First, the trust document must allow for the purchase of life insurance. This can usually be discerned from a review of the document or the governing state law.

Another legal issue related to control concerns are situations where the surviving spouse is a co-trustee of the trust. This is a common practice as it often helps ease client anxiety over placing these assets in a trust. In order to avoid any risk of the life insurance death benefit being included in the survivors estate, it is recommended that the survivor resign as trustee.

While some very tight legal drafting that limits the spouses decision-making capacity and access to life insurance values may allow a spouse to remain as co-trustee, a clean separation from the role as trustee is a more conservative approach.

Finally, it is important to remember that your clients trusts will have varying amounts of assets available for planning. Although $1 million is used in this example, most client trusts will have smaller amounts available for planning.

This is due to the fact that the $1 million exemption equivalent only has been in place for a short period of time. Many trusts were funded some time ago, when the Unified Tax Credit amount was much lower. In 2001, this amount was $675,000–and that was an increase over prior years.

Additionally, some clients may not have had sufficient assets to fully fund their credit shelter trusts or they may not have properly structured the ownership of their assets to maximize funding the trusts at the death of the first spouse. Before doing any life insurance illustrations, you will want to know what amount is available for planning within a given trust.

A funded credit shelter trust can offer an attractive way to help a client, or surviving spouse, complete a segment of his or her estate plan. In many cases, life insurance may provide sufficient leverage for assets held in such a trust to boost the amount available to the heirs. With the appropriate planning and life insurance design, this approach can be an attractive concept to bring to your clients and advisors who have access to credit shelter trusts.

Mark A. Teitelbaum, JD, LLM, CLU, ChFC, is second vice president of advanced sales for Travelers Life & Annuity, Hartford, Conn. He may be contacted at mark.a.teitelbaum@citigroup.com.


Reproduced from National Underwriter Edition, May 19, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.