Estate Planning for Beginners, Part Six

Credit shelter trusts (CST) are an incredible income tax planning tool for the survivors named as beneficiaries.

The following examples of language to be used are not intended to be legal advice as only a qualified estate planning attorney can offer legal advice. (For more, see: Estate Planning for Beginners, Part One.)

Traditional language for surviving spouse:

“All of the income from the trust 'shall be' distributed to my spouse at least quarterly.” This language leaves no options. The trustee is “required” to distribute all the income at least quarterly. As a young trust officer years ago, this was the language used most often. This type of CST is known as a simple trust, one that requires that all income be paid out to the beneficiary at least annually

Optional language we may use today:

“The income 'may be' paid to a class of beneficiaries consisting of my spouse and/or our lineal descendants in equal or unequal proportions as the trustees may determine in their absolute discretion.” However, the needs and desires of my spouse shall always come first and foremost.” Any income that is not paid out each year shall be added to principal at least annually. (This is a guidance clause for the direction of the trustees). This type of CST is known as a complex trust as it allows for the accumulation of income rather than required annual distributions. (For more, see: Estate Planning for Beginners, Part Two.)

Note the options presented to the trustee(s):

  • If the spouse needs all the income, she can get it. 
  • If a court or creditors asserts claims again the spouse, the trustee can hold back income distributions until a resolution can be reached, more favorable toward the surviving spouse.
  • If instead there is a reason to pay the income directly to her daughter, the trustee has the power to do so.
    • Note: The surviving spouse can act as sole trustee. However, if she does want to have the income (“sprinkled”) to any other permissible beneficiary other than herself, she will need the power to name an “independent” co-trustee to do this properly.
  • A very similar clause can be used for the distribution of the trust’s principal to or for the benefit of the spouse and/or lineal descendants.

Avoid Need for Court Appointed Conservator

Although this will be applicable to both a testamentary trust and a living trust, by appointing your named trustees to act on behalf of the beneficiary, there would be no need for a court appointed conservator or for a guardianship appointment as this has been taken care of using these documents. (For more, see: Estate Planning for Beginners: Part Three.)

Future Appreciation of Assets Not Taxable in Estate of Second Spouse to Die

This can best be explained as follows. When assets coming from the first spouse to die are transferred into the CST, they are not her property and are not owned by the surviving spouse. What you are doing is giving the spouse “life use” of these assets rather than outright ownership. In this manner, at the death of the second spouse, the assets pass on to the named beneficiaries at the CST cost basis, either carried over from the date of death of the first spouse or for those assets that have been bought during the lifetime of the surviving spouse and owned by the CST, at their cost basis to the trust.

Cost basis and carryover basis, two very important subjects, will be covered in the future.

Estate Tax Savings

Although some of our clients see this as a major advantage for using a CST, I don’t necessarily place a lot of weight on this issue due to the size of the federal exemption.

For those families with total assets of less than $5.49 million, you may remember that there will be no federal tax. We then look to the state and to the extent a state “estate tax” or “inheritance tax” may be applicable, we try to fund the credit shelter trust up to a maximum of the state exemption to avoid some or all the state's estate tax at the death of the second spouse. This is not very difficult.  However, it does need careful drafting by a competent estate planning attorney. (For more, see: Estate Planning for Beginners, Part Four.)

For those married couples with combined assets of $10.98 million, our recommendation would be to fully fund the credit shelter trust at the death of the first spouse up to a maximum of $5.49 million with language that will increase this amount due to the permanent nature of the cost-of-living increases that have been passed by Congress. In this manner, the assets of the credit shelter trust will be exempt from federal estate taxes at the death of the second spouse and with a second full exemption for the surviving spouse, no federal estate taxes should be due if properly planned, at least at the federal level.

Note: As of December 31, 2016, 15 states and the District of Columbia had an estate tax and six states an inheritance tax. Maryland and New Jersey have both.

Jurisdiction of the Probate Court

As you may remember from prior discussions, the use of the living trust has the advantage of eliminating the need for probate court jurisdiction for the lifetime of the trust. However, the assets must be in the trust at the time of death. This is not true when a testamentary trust is used as the trust remains under the jurisdiction of the court until the trust is terminated.

The take away to this discussion should be the value of using a credit shelter trust as a tool in our planning bags of goodies. Does it play into every estate plan?  Of course not. Should it be a consideration, absolutely. As planners, we need to understand when and where it may be appropriate. (For more, see: Estate Planning for Beginners, Part Five: Credit Shelter Trusts.)