Other Trusts
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Credit Shelter Trust
Used correctly, a credit-shelter trust can double the amount you and your spouse leave to your children free of federal estate taxes. Here is an example based on the $2.5 million exemption amount allowed in 2007. Suppose you leave your entire $5.0 million estate outright to your spouse. After your death, your estate incurs no federal estate taxes because of the marital deduction. But upon the death of your spouse in 2007, only half of the estate ($2.5 million) is exempt. Your children will pay up to $1,125,000 of federal estate taxes on the other half. That's poor planning.
Instead, suppose you willed only $2.5 million to your spouse outright, and put the other $2.5 million in a credit-shelter trust. Your spouse would be entitled to income from the trust after your death. But after the death of your spouse, the assets in the trust won't be part of your spouse's estate, so they'll also pass tax-free to your children. And the other $2.5 million is also untaxed due to your spouse's own $2.5 million exemption. Assuming no appreciation or depreciation of the assets’ values, your children inherit $5.0 million free of estate tax.
To ensure that your children will enjoy these savings, your spouse should have a credit shelter trust in his or her estate plan. Also, each spouse should have assets valued at the exemption equivalent amount in his or her own separate name to leave to those trusts.
A word of caution: to maximize the advantages provided by the tax law, a review of your will, trusts and any other estate planning documents is in order. As the new exemption limits go into effect, wills that mention $1.0 or $1.5 million figure, for example, may need to be rewritten, and individuals who have carefully divided their assets so that each spouse has at least $2.5 million in assets may have to adjust their holdings. The increase in the exemption amounts means that, with proper planning, married couples who can exempt $5.0 million of assets today, could exempt $7.0 million as of 2009.
Irrevocable Life Insurance Trust (ILIT)
Life insurance proceeds become part of your estate and are subject to estate taxes if you own the policy or have incidents of ownership in the policy at your death. But by setting up an irrevocable trust and making it the original owner and beneficiary of your insurance policy while you're still alive, the proceeds may be kept out of your estate -- which means tax savings.
After the trust is established, you can make yearly payments to the trustee who, in turn, can pay the premiums. The proceeds of the policy may be held in trust and made available to provide income to your spouse and children, or anyone else whom you designate in the trust document. The cash in the trust may be used to pay estate costs on a very tax-efficient basis.
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