Podcast Summary: The Practical Planner

Episode: Everything You Need to Know About Credit Shelter Trusts

Date: October 8, 2024
Hosts: Thomas Kopelman, Anne Rhodes, David (last name not given)

Overview

This episode dives deep into credit shelter trusts (also known as "family trusts") and their critical role in estate planning. The hosts—Thomas, Anne, and David—discuss what credit shelter trusts are, their tax benefits, how they compare to marital and survivor’s trusts, the impact of tax law changes, and what advisors should look out for in clients’ estate documents. The conversation is practical and advisor-focused, with clear takeaways for recognizing trust structures and maximizing client outcomes.

Key Discussion Points and Insights

1. What is a Credit Shelter Trust (CST)?

• Definition and Purpose:
  • CSTs are mainly tax planning tools, designed to "shelter" the estate tax exemption of the first spouse to die, so it isn't wasted.
  • They can exist even if a client is comfortable giving everything to their spouse outright, as they specifically preserve a tax attribute.
  • Quote (Anne, 01:34):

    "Credit shelter trusts, unlike marital trusts, have a very tax-driven motivation behind them. Marital trusts may be a little bit more about controlling assets for your spouse... but at the heart of them, the credit shelter trust... is about preserving a tax attribute."

• Key Use Case: For married couples facing a potential estate tax at the federal or state level, especially in states with low thresholds (e.g., Massachusetts).

2. Federal and State Estate Tax Relevance

• Threshold Variance:
  • Federal estate tax exemption is currently $13.61 million (2024), but this amount can change with political winds.
  • State-level exemptions can be much lower, e.g. Massachusetts recently increased theirs from $1M to $2M.
  • CSTs preserve the exemption from the first spouse to die, potentially halving or eliminating tax due on the surviving spouse's death.
  • Quote (David, 02:33):

    "It's really important that you know whether you have a state tax issue if you're going to use a credit shelter trust, because there can be some downsides... where you have no estate tax issue at all."

3. Why Include a CST? Flexibility Amid Uncertainty

• Planning for Change:
  • Exemption amounts are unpredictable ("a political football"), so it's prudent to include the option for a CST in estate documents—sometimes known as "Hail Mary planning."
  • It offers critical flexibility if either laws change or the client's wealth unexpectedly increases (e.g., winning the lottery).
  • Quote (Anne, 04:21):

    "There is still very much a point to having a credit shelter trust because... if there is any estate tax issue at death potentially... at least preserve the option to have a credit shelter trust in your documents."

4. Design Choices: Rigid vs. Flexible Funding

• Rigid Funding Formula:

  • Documents can "hard code" how assets are allocated to a CST, based on the estate tax exemption at time of death.
  • Downside: If exemptions rise, clients may be forced into unnecessary CSTs, losing future opportunities for basis step-up and incurring more tax complications.
  • Quote (Anne, 10:33):

    "I've heard horror stories... where people were like, my God, I'm just going to pretend this trust doesn't exist... then you get into all sorts of other problems..."

• Flexible Structures (e.g. Disclaimer Trusts):

  • Gives the surviving spouse or executor up to 9 months post-death to elect whether and how much to fund a CST, based on the estate's actual situation.
  • Offers the opportunity to optimize based on current laws and asset composition at death.
  • Quote (David, 06:50):

    "You can make it more flexible... so that the surviving spouse has the option upon the first death whether to fund the credit shelter trust. And that's usually done... through a disclaimer."

• Clayton QTIP Election:

  • Provides even more flexibility, as the trustee (not just the spouse) decides asset allocation between marital and credit shelter trusts, with up to 15 months to make elections.
  • Quote (David, 19:49):

    "With the Clayton Q TIP, you effectively can usually get 15 months... so a little more restrictive in a certain way, but there’s more time there to make an election."

5. Selecting the Right Assets for a CST

• Best Practices:
  • Funding with items expected to appreciate, but not with the primary residence or retirement accounts (IRAs), due to tax treatment complexities.
  • Avoid placing assets that would benefit from a second step-up in basis into the CST, as they lose this advantage.
  • Quote (David, 20:26):

    "There are a lot of assets that you don’t necessarily want to go into the credit shelter trust... number one might be your primary residence... another is retirement accounts."

6. Advisor’s Role and Practical Actions

• Document Review:
  • Advisors should review existing trust documents for rigid CST funding formulas and suggest updates to add flexibility—especially as laws and client situations change.
  • It’s a vital advisor value-add, even without needing to master every technical detail.
  • Quote (Thomas, 17:24):

    "This is, right, the perfect place for an advisor to add value... Here’s a practical point to review and probably even another thing to then review again in two years."

7. Other Common Trust Structures: Marital and Survivor’s Trusts

• Marital Trust:
  • Primarily about asset control for the surviving spouse.
• Survivor’s Trust:
  • Used in community property states/joint trusts; functions as a revocable trust for the surviving spouse’s own assets after the first death.
  • Not about taxes or control, but simply a legal continuation of trusts for practical/titling reasons.
  • Quote (Anne, 24:09):

    "The survivor's trust is, and should be, a completely revocable trust that only gets formed at the first death... you need a place for the widow or widower's assets to go."

Notable Quotes & Memorable Moments

• On Planning for Uncertainty:
  • (Anne, 27:17)

    "I think the credit shelter trust is important for everybody to have. Even if you think your client—like there’s no way in hell that they're going to have (an estate tax problem)—it doesn't hurt to just put it in."

• Advisor’s Value Add:
  • (David, 27:32)

    "Couple extra pages in your document, maybe maximum, you know, that could offer so much in savings, so might as well have it."

• On Document Review:
  • (David, 16:39)

    "...those rigid funding formulas that are really disadvantageous for clients are, I’m telling you, probably the most common comment I would have on trusts that I would review. So they are out there. There are a ton of them that need to be updated or else there’s going to be a lot of capital gains taxes that are unnecessarily paid."

Timestamps for Key Segments

• What is a Credit Shelter Trust? — 01:34
• Estate Tax Landscape (Federal & State) — 02:33
• Why CSTs Still Matter Even When Not Needed Today — 04:21
• Rigid vs. Flexible Funding Formulas — 06:50
• Common Pitfalls with Rigid Funding Formulas — 10:33
• Real-world Examples: Funding Formulas & Flexibility — 13:02
• Clayton QTIP and Maximizing Flexibility — 17:44
• Best/Worst Assets for Funding CSTs — 20:13
• Survivor’s Trust: Role & Utility — 24:09
• Final Thoughts: Why Options Matter — 26:59
• Summary and Farewell — 28:14

Takeaways for Advisors

• Always include the option for a credit shelter trust in client documents, even if it seems unnecessary now.
• Prefer flexibility—avoid rigid funding formulas unless a client’s situation clearly warrants it.
• Review client estate plans regularly, especially before and after significant tax law changes (e.g., exemption "sunsets" in 2025).
• Know common trust structures and what they signal; “family trust” is often code for CST.
• Be prepared to guide surviving spouses and families at the time of a death, especially with asset selection/allocations for CSTs.
• Practical review of documents is a huge value-add for advisors, even without deep legal expertise.

This episode is an essential listen (or read) for any advisor wanting to guard clients against future uncertainty and add high-value insights to estate planning conversations.