Credit Shelter Trusts (CSTs) are an exceptional estate planning tool for extremely affluent couples who are looking for a tactical way to set up their financial future. And these powerful tools go far beyond just your future. They can also protect your loved ones when you’re no longer here to do it yourself.
Learn everything you need to know about CSTs - what does CST mean, how it works, what limitations you need to know about and whether or not they may be right for you - in this guide.
What is a Credit Shelter Trust?
A Credit Shelter Trust (CST) is a Trust that takes effect after the first spouse in a marriage passes away. At that time, assets placed in the CST are no longer part of the estate. This allows them to be held in the CST for the benefit of the surviving spouse during the remainder of his or her lifetime.
What does CST mean for final beneficiaries? When the surviving spouse also passes away, the Credit Shelter Trust then passes to remaining beneficiaries with no taxes due - the remaining beneficiaries are named in the original Trust. A huge benefit to a CTS is that assets within it are conditionally available to the surviving spouse.
What is the Purpose of a Credit Shelter Trust?
Now that we've covered the CST meaning, it's important to understand why you may want to use this estate planning tool. Affluent married couples use CSTs to protect their estate from taxation when the first spouse dies. It’s a strategic plan, as the Trust only becomes relevant once that first spouse passes away. CSTs can include part or all of an estate. The ultimate purpose of a CST is to create a tax-efficient way to keep assets in a Trust that can benefit a surviving spouse in a tax-efficient way.
One caveat, a CST must have a designated Trustee other than the surviving spouse if your goal is to avoid taxation. Note that this means the surviving spouse never has actual control over the assets. However, there are exceptions to this limitation, if named in the Trust (such as funds allowed for educational expenses or medical bills).
How Does a Credit Shelter Trust Work?
When you transfer assets to a surviving spouse, you can avoid federal estate taxes. When you pass away, the Trustee you have named in the Credit Shelter Trust funds the Trust. This can include any amount up to the lifetime federal estate tax limits (as of 2021, that threshold was raised to $11.7m per person or $23.4m per couple - up from the 2020 limit of $11.58m and $23.16m, respectively). Although the surviving spouse typically doesn't have access to the entire Trust, they can use income from the Trust to their benefit.
So, what happens when the surviving spouse dies? Once that happens, the CST simply passes to surviving final beneficiaries (who also must be named in the Trust). For couples who have a sizable estate that surpasses the tax limits, it might make sense to split assets to take full advantage of the applicable exclusions. Then, each spouse can draw up a CST on their separate assets.
Other Commonly Asked Questions About CSTs
It's important to understand how a Credit Shelter Trust works with other types of Trusts as well. Here are a few commonly asked questions regarding CSTs.
Is a Credit Shelter Trust a QTIP?
No. Credit Shelter Trusts are a popular tool for estate planning, and there are two main types of CSTs, the Marital Gift Trust and the Qualified Terminable Interest Property Trust (QTIP). Both of these Trusts preserve wealth via estate tax exemptions. But CSTs are not technically the same as QTIPs - as a QTIP is a type of CST.
Is a Credit Shelter Trust Revocable?
Sort of. In the beginning, a Credit Shelter Trust is a type of Revocable Trust. So, you can make changes to it while both spouses are still living. However, after the first spouse passes away, the Trust becomes irrevocable, and the assets in your estate are subject to the conditions of the CST. This is a plus for anyone who wants to protect their estate and beneficiaries from future marriages, for example.
How is Income From a Credit Shelter Trust Taxed?
A Credit Shelter Trust is also called a Bypass or AB Trust. It allows both spouses to take advantage of estate tax exemptions. The Grantor - another name for the person creating the Trust - includes the provisions of the CST in his or her Will. Both spouses can create CSTs to fully protect an estate from taxation.
The surviving spouse can take advantage of income from the Trust. However, they typically don't have access to the principal. If the surviving spouse also passes away, assets in the Trust pass to other heirs who have been named in the CST. This allows couples to pass down their estates to remaining family members, such as children, in a very tax-advantageous manner.
When the surviving spouse dies, the CST distributes the estate to final beneficiaries. Generally, inherited money is not taxed. That's because the person who passed away already paid taxes on the money prior to dying. Of course, there are exceptions, such as when the estate surpasses the federal estate and gift tax threshold. A qualified Estate Planner can help you wade through the ins and outs of the legal issues.
Credit Shelter Trust vs Marital Trust - Is a Marital Trust the Same as a Credit Shelter Trust?
No. A Marital Trust is a type of Credit Shelter Trust. You and your spouse can use a Marital Trust to pass assets to a surviving spouse, children or grandchildren. When the person named in a Marital Trust dies, the assets pass to the Trust and the surviving spouse can use the income generated from the Trust but not the principal.
Marital Trusts include a Power of Appointment, QTIPs and Estate Trusts. It's important to understand each of these estate planning tools and how they can benefit you and your family prior to making a decision on which one to include in your Will.
Create Your Credit Shelter Trust Today
Credit Shelter Trusts can be a wise investment in your financial future and legacy. Understanding how something can help protect your estate and your loved ones is key any time you’re considering an estate planning tool. If you have a very large estate, and you’re looking for a smart, strategic way to set up and protect your financial future, then Credit Shelter Trusts may be the way to go.
If you’re looking to start or revamp your Estate Plan, Trust & Will can help. Our online estate planning tools are created by lawyers and estate planning experts who understand just how important your Estate Plan is. Credit Shelter Trusts can be a viable solution for those who want to ensure they’ve thought about a long-term plan in regards to finances and their loved ones.
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