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________________________________________________ Credit Shelter Trusts
/ Estate Planning Strategies If you are like many people, individual retirement accounts (IRAs)
and other retirement plans may constitute a significant portion
of your estate. In the past, fully using the gift and estate tax
applicable exclusion amount (currently $650,000) in such a situation
was difficult because participants could not name revocable trusts,
such as credit shelter trusts, as beneficiaries. The only trust
option -- irrevocable trusts -- often limited flexibility and increased
the fees involved in creating an effective estate plan. But under
proposed U.S. Treasury regulations, you can now name a revocable
trust or a trust established under your Will as beneficiary of your
retirement accounts, as long as the trust becomes irrevocable on
your death. How
Credit Shelter Trusts Work Currently, married couples may protect $1.3 million in assets (twice
the applicable exclusion amount) from estate tax if both spouses
fully use their own applicable exclusion amounts. To take full advantage
of the available tax savings, however, each spouse must own assets
worth the full amount of the exclusion at death. Married couples
may transfer assets from one spouse to the other without gift tax
to ensure that none of the applicable exclusion amount is wasted
on the death of either. As a general estate planning technique, on your death assets equal
in value to the applicable exclusion amount can be placed in a credit
shelter trust to be held for the benefit of your surviving spouse
and descendants. The trust then provides income to your spouse during
his or her lifetime and can provide principal payments if needed
to maintain his or her lifestyle. If set up properly, this trust
is not taxable in the surviving spouse's estate. The proposed Treasury regulations make it easier to use retirement
accounts to fund credit shelter trusts. For example, let's say you
own an IRA with a value of $1 million, and the value of all your
other assets, including the residence and liquid assets of you and
your spouse, are worth $650,000. Under the proposed regulations,
you may use a portion of the IRA to fund the credit shelter trust,
so that both you and your spouse can fully use the applicable exclusion
amount. After your death, retirement account distributions may be made
to the credit shelter trust as a named beneficiary. Your spouse,
and in some cases your descendants, can receive an income interest
in the credit shelter trust. In some instances, it is possible to
have the payments from the retirement account made to the credit
shelter trust over your spouse's life expectancy. Care should be
used in structuring the credit shelter trust so that, if desired,
payments and taxes can be deferred as long as possible. The estate tax savings from naming the credit shelter trust as
the beneficiary of a retirement account do have a cost, however.
Your spouse loses the ability to further defer income taxes by rolling
over the retirement account into his or her own IRA. And the portion
of the retirement distribution that remains in the trust as principal
is taxed at the highest marginal income tax rate of 39.6%, unless
the trust also complies with the "defective" grantor trust
rules (which is a topic of another article). Qualified
Disclaimers Add Flexibility Determining what portion of the retirement account should pass
to the credit shelter trust can be difficult due to such uncertainties
as the health and life span of you and your spouse and future cost
of living. Rather than predetermining the portion of the retirement
account that will pass to the credit shelter trust, your spouse
may prefer to make that determination after your death. With planning,
this option is available through the use of a qualified disclaimer. A disclaimer is the refusal to accept all or a portion of a benefit.
If your spouse is named as the primary beneficiary of the retirement
account and the credit shelter trust is named as the secondary beneficiary,
then any portion of the retirement account that is not accepted
by your spouse will pass to the credit shelter trust. Your spouse
may wish to disclaim that portion of the retirement account that
results in the use of your entire applicable exclusion amount after
taking into account other assets available for that purpose. You should ensure that a proper disclaimer can be made. A disclaimer
is not allowed more than nine months after the date that a surviving
spouse is irrevocably named as the beneficiary of the retirement
account. When
To Use Retirement Funds Generally, only use retirement accounts to fund credit shelter
trusts if other assets are not available. Retirement accounts, which
are subject to income tax, are less desirable for funding a credit
shelter trust because the amount sheltered from estate tax is reduced
by the income tax paid. The effect is that the amount that will
eventually pass to your children or other beneficiaries is reduced.
Consider other assets before the use of a retirement account, including
cash, Roth IRAs and assets that receive a stepped-up basis on your
death, such as securities or real estate. If the retirement account is payable directly to your spouse, then
income tax paid on the retirement account reduces the amount that
will later be taxable in your spouse's estate. If other assets are
not available, then using retirement accounts to fund credit shelter
trusts may be a better option than wasting the applicable exclusion
amount. Planning
Considerations As retirement accounts become a disproportionately high percentage of your wealth, and as the estate tax applicable exclusion amount grows to $1 million, greater consideration will need to be given to using such accounts for credit shelter trust planning. If you would like to see if using retirement accounts to fund a credit shelter trust is right for you, please call us to discuss this estate planning tool in greater detail.
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Copyright 2001 Fahlman & Olson. All rights reserved.
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