A credit shelter trust is an irrevocable trust established after the death of a married spouse for benefit of the surviving spouse. The primary purpose is to shelter the deceased spouse’s available credit against the estate tax.

Do We Need A Credit Shelter Trust?

There is an unlimited estate tax deduction for property left to a surviving spouse. This eliminates any estate tax when the first spouse dies, but may not protect the property from estate tax when the surviving spouse dies.

How is the Credit Shelter Trust Funded?

There are generally two ways to fund the credit shelter trust.

  • By mathematical formula. The document might allocate as much of the deceased spouse’s property to the credit shelter trust as possible without triggering an immediate estate tax. This is a mandatory funding method because the plan must be carried out.
  • By disclaimer. An alternative method is the disclaimer funding method, which gives the surviving spouse the discretion whether to fund the credit shelter trust. This might be appropriate if funding the trust would not be likely to save any taxes. This method is optional.

What if the Surviving Spouse Needs the Money?

The credit shelter trust typically grants the surviving spouse access to trust income and principal.

May the Surviving Spouse Act as Trustee?

Yes, the surviving spouse may serve as trustee of the credit shelter trust. If the spouse serves as the sole trustee he or she must be restricted to using income and principal for needs related to health, education, support and maintenance.

Should There be a Co-trustee?

To ensure that the trust is invested wisely and the assets used for the intended purpose, the grantor could name a third party to act with the spouse or independently.

What Happens When the Surviving Spouse Dies?

When the surviving spouse dies, the remaining assets are distributed according to the terms of the trust. All of the assets in the credit shelter trust, including any appreciation in value during the surviving spouse’s lifetime, pass free of estate tax to the beneficiaries.

What About Portability?

Portability is a new concept. It allows the surviving spouse to claim the deceased spouse’s exemption for later use even though the assets pass outright to him or her instead of in a credit shelter trust.

Which is Better: A Credit Shelter Trust or Having My Spouse use Portability?

  • It depends. There are several factors that may or may not apply to your situation. These include:
  • Loss of Ported Exclusion After Re-marriage: If the surviving spouse remarries, he or she may lose the exemption that was ported from the deceased spouse.
  • State Inheritance and Estate Taxes: Portability applies to the federal basic exclusion amount; it does not apply to state inheritance or estate taxes. If your state imposes a tax, you need a credit shelter trust to preserve any available exemption.
  • Generation Skipping Tax Exemption: The generation skipping tax exemption is not portable. If you wish to maximize a trust that will be free of estate tax at a child’s death, the bypass planning is necessary.
  • Inflation: The amount of the “ported” exemption is fixed in the year the first spouse dies. If the deceased spouse’s property appreciates, this portion may be taxed. With a credit shelter trust, any increase in value is sheltered from tax.
  • Preserving the Assets: A credit shelter trust is typically exempt from claims by a spouse’s creditors and the marital rights of a new spouse. It also controls how the assets are distributed at the survivor’s death, rather than subjecting them to the will of the surviving spouse.

Credit shelter trusts serve many purposes. I encourage you to consult with your CCM advisor about the benefits of trusts in your estate plan.

NOTE: The information provided in this article is intended for clients of Carlson Capital Management. We recommend that individuals consult with a professional adviser familiar with their particular situation for advice concerning specific investment, accounting, tax, and legal matters before taking any action.