Starting in 2011, widows and widowers can add their unused estate tax exemption of the spouse who died most recently to their own. This provision, plus an increase in the exemption amount to $5 million per person, enables married couples together to transfer as much as $10 million tax-free to their children or other heirs–either by making lifetime gifts or through an estate plan.
Portability–the ability of a deceased spouse’s credit to be transferred to the surviving spouse–is an extremely positive development that can simplify planning for many people. But for others it raises tough choices about whether to abandon more complex estate planning tools that may have other advantages. To further complicate matters, portability only applies to deaths in 2011 and 2012. So until Congress makes it permanent, there is a risk that it will expire before most folks can take advantage of it. Agents and advisers can expect clients to ask: “Why do I need a credit shelter?”
Basic credit shelter trust. When the first spouse dies, the trust is funded with up to the exemption amount. The trust distributes income and principal to the survivor or other family members (usually the couple’s children) while the surviving spouse is alive, then passes on whatever is left to family. Funds in the trust are covered by the exemption amount and are not taxed when the first spouse dies. Nor are they considered part of the survivor’s estate, so they are not subject to tax when she dies.
Now that portability makes it unnecessary in most cases for spouses to use a credit shelter trust solely to preserve the federal exemption amount, is this planning device defunct: Not by a long shot. Still, it’s never been for everyone, and far fewer people may need it now than in the past. Whether your clients are among them depends on various factors, including their net worth, family relationships, investment outlook and tolerance for complexity. Here are some reasons to use, or not use, a credit shelter trust.
Protect the inheritance from creditors. Preserving resources for your client’s heirs goes beyond sound investment and money management. You also need to guard against the possibility that, sometime in the future, the objects of their bounty could lose assets to their own creditors. They may include everyone from disgruntled spouses and ex-spouses to people who win lawsuits against the family.
Leaving assets to heirs in a family trust, rather than outright, is an excellent means of sheltering family assets from creditors. For many people this is the main reason to set up trusts and to leave assets permanently in this legal wrapper.
Spouse might remarry after client’s death. This raises a couple of additional concerns. One involves children if they don’t get along with the stepmother or stepfather. Picture this: surviving spouse commingles everything with this great-unknown quantity and the kids get completely cut out. Stranger things have happened. With a bypass trust, your client can avoid that result.