A comprehensive estate plan typically includes more than just a Last Will and Testament. One or more trusts are frequently incorporated into an estate plan. Trusts come in numerous forms and can serve a wide variety of purposes. One type of trust that is popular with married couples is the credit shelter trust, also known as a bypass trust. Only you and your estate planning attorney can decide if a credit shelter trust is right for your estate plan, but a basic understanding of how one works can help you discuss the option with your attorney.
Each individual tax payer is allowed a lifetime credit against estate taxes known as the lifetime exemption. For the year 2013, the lifetime exemption amount is set to return to $1 million. Anything above that in an estate at the time of death is taxed. For 2013, the estate tax rate is 55 percent. Imagine then that a couple has an estate valued at $2.5 million. If one spouse dies in 2013, he or she can leave the surviving spouse his or her share of the estate assets without incurring estate taxes because of the marital deduction. So far so good, but when the surviving spouse dies he or she now has an estate valued at $2.5 million — $1.5 million over the lifetime exemption amount. At the 2013 tax rate, the estate will lose $825,000 to estate taxes.
A credit shelter trust allows the first spouse to put his or her share of the estate assets into a trust. The surviving spouse has access to the trust income and the principle for things like support and medical care but does not have unfettered control over the assets. When the surviving spouse dies, the assets transfer to beneficiaries free from estate taxes. The estate is then only taxed on the $250,000 that is in excess of the lifetime exemption from the surviving spouse’s estate, saving the estate $687,500.