Funding A Credit Shelter Trust With Retirement Benefits

By Natalie B. Choate Bingham Dana LLP, Boston, MA

There are numerous advantages as well as disadvantages to funding a credit shelter trust when all or most of the client's assets are inside retirement plans.

This article is excerpted from the forthcoming 2002 edition of the author's book Life and Death Planning for Retirement Benefits (Ataxplan Publications, 4th ed. 2001; www. ataxplan.com), with permission of the author and publisher. Copyright 2001 by Natalie B. Choate.

This article discusses the problem of ehow to fund a credit shelter truste when all or most of the client's assets are inside retirement plans. While in some cases the problem can be solved while still achieving all of the client's estate planning goals (see Solutions B and C), in other cases the client will have to choose between mutually exclusive competing objectives (see Solutions A, D, H and J). Finally, some ideas that are advanced as solutions to this problem may not work as well as hoped (or at all) (see Solutions E, F, G and I).
This article is intended to provide a quick and practical guide to alternatives available for this particular problem, not a complete explanation of applicable tax law (with which the reader is assumed to be already familiar). Statements about required distributions are based on Internal Revenue Code Sec. 401(a)(9), as interpreted in the Proposed Treasury Regulations on minimum distributions issued January 2001 and revised March 2001 (Sec. 1.401(a)(9)-0 et seq.), which have been previously summarized in other articles in this Journal. Other citations have been left out since most of the statements of estate planning law and techniques are common knowledge to estate planners.

What The Problem Is
And Who Has It
There are significant income tax disadvantages to using retirement benefits to fund a credit shelter trust of which the surviving spouse ("Spouse") is a beneficiary. These income tax disadvantages 1) may reduce or eliminate the estate tax savings that is supposed to be obtained by using a credit shelter trust and/or 2) may reduce the amount of money Spouse has available to live on as compared with leaving the benefits outright to Spouse.
The clients who have this problem are a married couple old enough and rich enough to care about estate taxes, but whose assets outside of retirement plans are less than the optimal credit shelter amount. For example, assume it is 2002 and the estate tax exemption (credit shelter amount) is $1 million. The couple's assets exceed $1 million. The eoptimal credit shelter amounte is therefore $1 million.
The problem comes in two forms:
e The spouses have enough non-retirement plan assets to fund the optimal credit shelter amount for one spouse, but not both.
e The spouses have no assets or only insignificant assets outside retirement plans, so neither spouse can fund a credit shelter trust unless retirement benefits are used for that purpose. (If all of the retirement benefits are in one spouse's name, there is an additional problem, not treated in this article, namely, ehow to fund the credit shelter trust of the non-participant spouse.e)