Not All “Shelter” Trusts Are The Same

There are different ways to shelter the credit federal law provides U.S. citizens against the federal estate tax.  Not all trusts designed to shelter that credit are the same.  The objectives from a tax planning point of view usually is to ensure the surviving spouse benefits from the funds and has access to them for his or her needs and at the same time design the trust so the assets in the trust will NOT be exposed to the federal estate tax in the survivor’s estate.  In effect, proper planning helps ensure the credit of the first spouse is not WASTED.  If that credit is wasted, then there can be a substantial amount of federal estate tax due upon the death of the second spouse (usually due within 9 months).

In sum, the principal aim of the “credit shelter trust” or “the family trust” or the “bypass trust”, is to avoid imposition of unnecessary estate taxes on these funds when the survivor of a married couple passes. 

In light of recent changes in the law which increase the credit amount for U.S. citizens, the REAL questions are:

How should I design my credit shelter trust?

Who should the trustee be? 

Who should the beneficiaries be? 

Option I:            All income to spouse annually. 

Principal to spouse for needs related to health, maintenance, and support.

Here, spouse is sole beneficiary.  The spouse can be the trustee as well.  Here, the focus is on providing for spouse.  When a shelter trust is designed this way, it is appropriately referred to as a Credit Shelter Trust or a Bypass Trust.  The main purpose is to provide for spouse and avoid taxes on second passing (“bypassing” their estate).  Here, we want maximum freedom for survivor of married couple.

            Option II:        All income to spouse and or family. 

Principal to spouse and or family for their needs related to health and maintenance. 

Here, spouse is not sole beneficiary.  He or she may be the primary beneficiary.  Actually, the family members are all beneficiaries.  When a shelter trust is designed this way, it may more appropriately be referred to as the Family Trust.  The benefits of this structure are it is more flexible and can benefit more people.  The disadvantages of this structure are all current beneficiaries are entitled to notice annually of the trust assets.  Here, there may be arguments and spouse may not get the proper support they need. 

            Of course, there are many more variations of the credit shelter trust, but Option I, or a variation of the same, will be more attractive if you do not wish to have the obligation to report the value of the trust funds to your children every year.  Option I will also be attractive if you want your spouse to have control, and you want to ensure that your spouse’s needs will be met.  In light of the market downturn and the increased credit amount, option I will be more attractive to most.  Option II, or a variation of the same, may be more attractive if there will be plenty of funds that the survivor will have of their own.  If that is the case, then the survivor’s need or concern over the funds in the credit shelter trust diminishes during their life and the trust could be more appropriately called a “family trust”. 

Every case is unique.  You should always be aware of your options.  To this end, when you obtain counsel to protect your assets and plan your estate, you should request an “in person” review of your papers.  An “in person” review makes sure it is you who are being served.  This review should provide you with a good understanding of how the plan actually works and why.  This will help accomplish the higher aim of the practitioner which is to ensure you have made informed decisions.  That’s how we make it your plan.  

Contributed by:

Mark F. Winn, Attorney at Law