Married couples in the United States can use a credit shelter trust to help minimize the estate taxes due when each spouse dies. Two trusts are used in this estate planning technique, trust A and trust B. Trust A contains the property that passes to the surviving spouse, estate-tax free, due to the unlimited spousal exemption. Trust B contains the property that will be passed on to the couple's heirs, usually their children. Credit shelter trusts are also called AB trusts, A/B trusts, or bypass trusts.
The spouse has the right to all of the income generated by trust A, known as the survivor's trust. He or she also has the rights to the principal amount in the trust. The survivor can also change the trust and has the unlimited power to assign the principal to anyone. It is essentially the spouse's property. Assets in this trust are generally subject to estate tax upon the surviving spouse's death.
Trust B, called the credit shelter trust, is used to set aside property that will be passed on to the heirs when the surviving spouse dies. The amount put into the credit shelter trust is limited to the current estate tax exemption, which can change each year. The surviving spouse has the right to all the income that trust B generates during his or her lifetime. The spouse can also use the principal to pay for health or general life maintenance costs.
The spouse cannot change trust B or assign the principal to anyone. The spouse does not own the assets in the credit shelter trust. When he or she dies, the property in the trust passes on to the heirs named in the trust. Typically, the property is not subject to estate tax.
Remarriage by the surviving spouse can cause problems with a credit shelter trust. Trusts that are not set up until after the first spouse dies may be changed by the survivor. If he or she then remarries, the original couple's children may not receive their inheritance as intended. To alleviate this problem, the credit shelter trust can be set up and implemented while both original spouses are still alive.
An alternative to using a credit shelter trust is to purchase life insurance policies with various beneficiaries to pass on property and limit tax liability. If an irrevocable life insurance trust is set up as the insurance policy owner, the value of the policy is not subject to estate tax. Generally, life insurance proceeds are also not subject to probate or federal income tax. This will help ensure that all heirs get their inheritance as planned by the estate owner.
Credit shelter trust is a term specific to estate planning in the United States. Other counties and territories use different terminology for trusts used in wills and estate planning. The amount of money protected from estate taxes — also known as inheritance taxes — by using these trusts, also varies by country.
