Evaluating whether a credit tax shelter makes sense

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Financial advisors should help clients evaluate whether a credit shelter trust makes sense for them.

Portability -- the ability to “port” a deceased spouse’s unused estate tax exemption for use by the surviving spouse -- is permanent, says Anjali Jariwala, founder of FIT Advisors in Chicago.

“The question now is whether there is still need for a credit shelter trust which historically was used to preserve a spouse’s estate tax exemption,” she says. “Credit shelter trusts can still have value in certain scenarios, which should be evaluated to determine if the benefit outweighs the cost of setting up the trust.”

Unlike the estate tax exemption, the “generation skipping tax” exemption isn’t portable, and this could result in potential loss of exemption if not entirely used up by the first spouse, Jariwala says.

In order to preserve a spouse’s GST exemption, property equal to the unused GST exemption amount can be placed into a credit shelter trust and a GST exemption allocated to it.

Assets that pass outright to a spouse may be at risk to creditors or divorce if the spouse remarries, Jariwala says.

Placing property in a credit shelter trust that passes to the surviving spouse remains creditor-protected. The assets are also divorce protected, to the extent the assets aren’t used to support the marital lifestyle.

Assets that pass outright may also be at risk with unwise financial planning decisions, Jariwala says.

A trust provides an added level of protection as the trustee is designated the job of overseeing the trust. Further, language can be written in the trust that limits the distribution of trust assets.

“This may be of value if a spouse is concerned the surviving spouse will spend down the assets in a rapid manner,” Jariwala says.

The estate tax exemption is indexed for inflation, but any amount ported over to a surviving spouse isn’t, she says.

Assets passing to the surviving spouse may grow in value by the time the second spouse dies. If the assets grow in a credit shelter trust through use of the first spouse’s estate tax exemption, more property will be protected from the estate tax than if the exemption is ported.

Credit shelter trusts have been used to make use of a deceased spouse’s estate tax exemption while still giving the surviving spouse income, says David D. Holland, chief executive and certified financial planner at Holland Financial in Ormond Beach, Fla.

“With the estate tax exemption so high, the total combined estate has to have over $10.8 million to be taxed,” he says. “As a result, credit shelter trusts are used much less frequently.”

Katie Kuehner-Hebert is a freelance writer in Running Springs, Calif. She has contributed to American Banker, Risk & Insurance and Human Resource Executive.

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