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Some married couples may be thinking that, with estate tax exemption portability between spouses now permanent, they no longer need credit shelter trusts. But for many well-to-do couples, that’s not the case: Credit shelter trusts can offer substantial benefits that exemption portability doesn’t.
Before exemption portability, the primary purpose of credit shelter trusts was to ensure that a married couple could take maximum advantage of both members’ estate tax exemptions without having to transfer significant amounts of assets to their children (or other beneficiaries) on the first spouse’s death. Instead, assets of the first spouse to die — up to the exemption amount — would be transferred (tax-free under the marital deduction) to a credit shelter trust benefiting the surviving spouse.
The trust would distribute its income (and in certain limited circumstances, some principal) to the surviving spouse for life. Upon the survivor’s death, the trust assets would pass tax-free to the children under the first spouse’s estate tax exemption — leaving the survivor’s exemption available to transfer some or all of his or her own assets tax-free.
Since 2010, exemption portability has allowed a surviving spouse to use any of his or her deceased spouse’s unused estate tax exemption — provided an election is made on a properly filed estate tax return. This means that all of the assets of the first spouse to die can be transferred directly to the surviving spouse without sacrificing the first spouse’s exemption. So a credit shelter trust isn’t necessary simply to preserve that exemption.
However, a credit shelter trust can still allow a couple to transfer more assets tax-free. How? The estate tax exemption protection applies not just to the dollar amount that’s initially transferred to the trust, but to any future growth in the trust as well.
For example, let’s say you have $5 million of exemption available at your death, and a credit shelter trust is funded with that amount. Now let’s imagine that your spouse dies 10 years later, and by that time the trust has grown to $7.5 million. The entire $7.5 million can pass tax-free to your children — without using up any of your spouse’s exemption.
While the ability to leverage your exemption may be the biggest benefit of a credit shelter trust post-portability, it does offer other advantages over portability as well, such as creditor protection, generation-skipping transfer tax planning opportunities and preservation of state exemptions. So even with portability available, you may still need a credit shelter trust to achieve your estate planning goals.