Asian couple review their escrow documents
A credit shelter trust is used to help married couples with significant wealth hand over their estate to children or other beneficiaries after their death, without inheritance taxes. Credit shelter trusts are also useful for avoiding inheritance, protecting assets from creditors, and ensuring that a deceased spouse’s wishes are granted. While they are primarily useful for large estates, couples with sizeable financial assets can get important benefits from using credit protection trusts as part of overall estate plans. Consider working with a financial advisor when creating or updating your estate plan.
Background on inheritance tax
The main purpose of a credit shelter trust is to reduce federal inheritance taxes that are levied on assets that are transferred to heirs. Death or capital transfer taxes, as they are also known, have come in a variety of forms since the early days of the United States. They have existed in their current form since 1916.
Inheritance taxes can be substantial. The maximum rate applied to amounts greater than $ 1 million above the tax allowance is 40%. The allowance is inflation-indexed and is $ 11.7 million for individuals or $ 23.4 million for couples for 2021. Since few estates are this large, not many Americans actually pay a state inheritance tax, sometimes derisively referred to as a death tax. For married couples with enough assets, however, credit shelter trusts can be real money savers.
The inheritance tax exemption is currently due to expire in 2025. While it can be extended by Congress, it is likely that it will be different. Inheritance tax law changes frequently at both the federal and state levels, so it is important to stay up to date with the latest legislation to be able to plan effectively.
How Credit Shelter Trusts Work
A Credit Shelter Trust, also known as a Bypass Trust, B Trust, Exemption Trust, or Family Trust, is an irrevocable trust. Like all trusts, it consists of a contract between a settlor and a trustee. The trustor is the person who sets up the trust and provides the assets. The trustee is the person charged with overseeing the trust and ensuring that the terms of the trust are met. The trust agreement defines all of the assets that will be placed in the trust fund. This can be any form of property, including cash, stocks, bonds, real estate, and collectibles. The trust documents also describe how these assets will be distributed to the beneficiaries. For example, a trust can stipulate that assets are only distributed to a beneficiary after a certain age.
The story goes on
A credit shelter trust is formed after a partner dies in a marriage. All assets brought into the trust are deemed to be separate from the estate of the surviving spouse. This allows them to go to the beneficiaries tax-free after the death of the surviving spouse. During the lifetime of the surviving spouse, he can draw income from the assets held in the trust.
Benefits of Credit Shelter Trust
“TRUSTS” key on a PC keyboard
A credit shelter trust serves as a tax administration tool because assets transferred to a surviving spouse are exempt from federal estate tax. There is no limit to this amount. After the death of the second spouse, taxes are typically levied on any assets from that spouse’s estate that are passed on to the beneficiaries. However, assets deposited in a credit shelter trust are not considered part of the surviving spouse’s estate. This means that they can be passed on to the beneficiaries tax-free after the death of the second spouse. An increase in the value of the trust assets can also be inherited tax-free.
As an example of how this works, imagine a married couple with a $ 15 million estate. Without estate planning, the estate on the death of the second deceased spouse would be $ 3.3 million over the federal inheritance tax exemption of $ 11.7 million in 2021. At a top tax rate of 40%, the estate would pay $ 1.32 million on the $ 3.3 million surplus. In addition, the first $ 11.7 million will be charged a property tax of $ 70,800. The total inheritance tax would be $ 1,390,800. A credit protection trust would avoid all of these taxes.
In addition to lowering taxes, a credit protection trust can help the surviving spouse fulfill the wishes of the deceased spouse. The trustee will ensure that the terms of the Credit Shelter Trust are met. For example, if the recently deceased spouse wants part of their estate to go to children of a previous marriage, this can be specified in the trust deed. Trust assets are also protected from creditors. And assets placed in the trust do not have to be abandoned.
Credit Protection Trust Limits
Credit shelter trusts are most useful when each spouse has enough assets to meet the amount of inheritance tax exemption. They are generally not used if the discount is less than the tax exemption.
A credit shelter trust is an irrevocable trust, which means that the terms of the trust cannot be changed. This means that careful consideration must be given to the needs of the surviving spouse when establishing the trust, as the surviving spouse has limited control over the property of the trust.
Credit Shelter Trusts are also required to file federal income tax returns. This can be time consuming and costly and must be included in the escrow documents.
Bottom line
Family does estate planning
A credit shelter trust is one of several different types of trust and can be effective tax management tools for estates large enough to trigger federal estate tax. They can also be helpful in ensuring that the surviving spouse is following the deceased spouse’s instructions on how to dispose of the property. Credit Shelter Trusts can prevent assets from going through the time-consuming and costly estate process. And they can protect a married couple’s assets from creditors after the death of a spouse.
Estate planning tips
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Credit Shelter Trusts are just one tool that can be used for estate planning. Working with an experienced and qualified financial advisor can help ensure that your estate is distributed the way you want, including minimizing inheritance tax. SmartAsset’s free financial advisor matching tool can connect you with up to three local advisors. Get started now.
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A free, easy-to-use retirement calculator can give you a good idea of how you are achieving your financial goals.
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How does a Credit Shelter Trust work? first appeared on the SmartAsset blog.