The Credit Shelter trust is known by many names including B Trust, Family Trust etc. It is the trust established at the death of the first spouse and funded with the exemption amt allowed under current tax law. Generally, the idea is that the assets in the B Trust are sheltered from estate tax and are designed to pass to the heirs at the surviving spouse’s death. Usually, there is not much focus of these assets for the surviving spouse since they typically have the “A Trust” as well as other assets from which to live. The documents usually read that any income from the B Trust goes to the surviving spouse—whether they want it or not. A vast majority of surviving spouses do not want nor need this income, however. All that income does is potentially drive the spouse to a higher tax bracket.
While the B Trust is an integral part of any good, basic Estate Plan what’s NOT said is important. These B Trust assets do NOT get a step up in basis at the death of the surviving spouse. What’s more, during the surviving spouse’s remaining lifetime the B Trust assets are subject to income tax and cap gains tax & taxes on dividends. These taxes are all at the Trust level, and the thresholds for the top tax bracket for a Trust are set extremely low when compared to an individual.
So what is a better way to pass these assets on to the heirs, shut off the tax problem AND get a step-up in basis on the assets? Very simply, all it takes is repositioning the assets, or part of the assets into insurance inside the trust. By doing so, the client will achieve the following:
- Shut off income taxes on those repositioned assets–insurance assets grow tax deferred.
- Shut off capital gains taxes and taxes on dividends.
- Provided substantial & immediate leverage to the assets thru the insurance proceeds.
- Provided a step-up in basis on those assets.
- Depending on the product used, provided significant guarantees via the death benefit on the insurance.
Typically, when you show a client the option of doing nothing and continuing down their same path versus the Leveraged B Trust Idea, the answer is quite obvious. Furthermore, most clients see the B Trust assets as “the kids money” since the surviving spouse has other assets on which to live. So this concept provides a terrific solution to maximize what the heirs receive, while shutting off the taxes.