Madison Eubanks

Sep 19, 2024

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6 Estate Planning Scenarios: When to Use Which Strategy

Estate planning strategies are like tools in a toolbox: Different tools do different jobs. Deciding which estate planning strategies to employ depends on any number of personal factors including (but not limited to) marital status, level of wealth, whether or not someone has children, charitable inclination, liquidity, and many more. A savvy planner takes all these variables into account and chooses the most appropriate tool for a person’s situation, values, and goals.

In this article, we provide fictional examples of when someone might use six different trust strategies, and illustrate how the right strategy can achieve their estate planning goals. 

1. When would you use a credit shelter trust? 

A credit shelter trust, also known as a bypass trust, is an estate planning tool typically used by a married couple with a large estate they want to minimize taxes on. 

Credit shelter trust example scenario

Seth and Sarah are a married couple who have a combined $18 million dollar estate they want to pass on to their children with minimal estate liability. Because the estate tax exemption amount in 2024 is $13.61 million per person, Seth and Sarah will be able to shield most of their assets from federal estate taxes with proper planning.

Seth passes away first, and his trust dictates that $13.61 million of his assets (the maximum individual exemption) will pass into a credit shelter trust rather than directly to Sarah. The trust terms give Sarah the ability to draw income from the trust without increasing the size of her own taxable estate. The value of the appreciation of the assets in the credit shelter trust will grow estate tax free. The remaining assets are distributed to Sarah outright.

When Sarah passes away, her taxable estate will only be the remaining ~$4.4 million that is distributed to her outright, shielding the majority of their estate from federal estate taxes and ensuring the majority of their wealth is passed to their children. 

2. When would you use a charitable remainder trust? 

A charitable remainder trust (CRT) is a type of trust designed to provide income to its beneficiaries (which can include the grantor) for a set time period before passing the remaining assets to a designated charitable entity. 

Charitable remainder trust example scenario

Tonya is a 67-year old retiree who owns a highly appreciable stock portfolio worth $2.5 million. She wants to sell her portfolio to diversify her investments and generate a reliable income stream for her retirement, but she wants to avoid the capital gains taxes she would encounter from selling the stocks. 

To achieve her goals, Tonya transfers her stock portfolio into a charitable remainder trust. Because the CRT is tax-exempt, it can sell the stocks without incurring capital gains taxes. The trust is set up to pay Tonya a set percentage of its value as an annual income, which will cover her living expenses. 

Upon Tonya’s death (or after a set number of years, depending on the trust’s terms), everything remaining in the trust will be distributed to a charity Tonya chose when she created the trust. In addition to avoiding capital gains taxes and contributing to charity, the CRT serves to remove assets from her estate, potentially reducing federal estate tax exposure.

3. When would you use a pot trust?

A pot trust, also known as a family pot trust, is a type of trust typically created by people who want to provide for multiple children or grandchildren of varying ages. The benefit of a pot trust in this case is that the trustee can distribute assets as they are needed by each beneficiary rather than simply dividing up shares. In other words, a pot trust allows the settlor to divide assets among beneficiaries equitably, if not equally. 

Pot trust example scenario

Elizabeth and Rachel, a married couple in their forties, have three minor children who they want to ensure are cared for if something happens to them while the children are still young. The couple wants to account for the fact that each child could have different needs or expenses at different times in their lives.

To this end, Elizabeth and Rachel set up a pot trust that will hold their assets if they pass away. Their three children are named as the beneficiaries and they appoint a dependable family member to be the trustee. 

In the event that Elizabeth and Rachel die before their children are adults, the trustee will be able to distribute funds from the pot trust to each child as needed for things like school tuition, medical expenses, sports team fees, and so on. This way, if one child has higher medical expenses than another, the pot trust can adapt to ensure those needs are met rather than allotting a specific amount for each child. 

The terms of Rachel and Elizabeth’s trust state that, upon their youngest child’s 21st birthday, whatever remains in the trust will be divided equally among the three children. 

4. When would you use a dynasty trust? 

A dynasty trust is a perpetual trust designed to hold and manage assets for multiple generations while minimizing estate taxes. It allows high-net worth families to grow and distribute wealth over time without incurring additional transfer taxes with each generational transfer.

Dynasty trust example scenario

Charles and Blaire are an ultra-wealthy married couple in their early 70s with an estate worth $40 million. They have two adult children and five grandchildren, but they want to ensure their wealth benefits future generations of their family as well. However, Charles and Blaire know they need to plan for the potential estate taxes that their wealth could be exposed to as it passes through generations. 

Luckily, Charles and Blaire live in Texas, which allows for near-perpetual trusts.They establish a dynasty trust and fund it with $30 million of their estate. Because the trust is designed to last indefinitely and removes the assets from their estate at their death, the assets and any appreciation of assets from the time it was funded are not subject to estate taxes when Charles and Blaire pass away. 

The trust is structured to ensure that its assets continue to grow and benefit current and future generations of Charles and Blaire’s family, while protecting assets from reckless depletion. 

5. When would you use an intentionally defective grantor trust? 

An intentionally defective grantor trust (IDGT) is an irrevocable trust structured to allow certain assets to be passed on without being subject to estate taxes while still retaining the settlor’s liability for income taxes generated within the trust. It’s “intentionally defective” because the grantor continues to pay income taxes on the trust’s earnings, but the assets are excluded from the grantor’s estate for estate tax purposes.

IDGT example scenario

Miguel, 55, is a successful businessman who owns a company valued at $22 million. He plans to leave the business to his two children, but wants to take measures to reduce the estate tax exposure as much as possible. He also expects the business to continue to appreciate, which could further increase the estate tax burden. 

To address this, Miguel creates an intentionally defective grantor trust and transfers the business’s ownership to the trust, which is structured so that Miguel is considered the owner for income tax purposes but not for estate tax purposes. 

Miguel sells the business to the IDGT in exchange for a promissory note of $22 million, which states that the trust will pay Miguel that amount over time from the income generated within the trust. Since it was a sale, there are no gift taxes due on the transfer. Additionally, since the payments made by the trust are not considered gifts, they don’t use up any of Miguel’s gift tax exemption. 

Because Miguel continues to pay taxes on income generated by the trust, the trust assets are able to grow without being diminished by income taxes, increasing the wealth that will be passed to his children. Over time, the business appreciates to be worth $30 million. Since the appreciation happens within the trust, the additional $8 million isn’t included in Miguel’s taxable estate. 

When Miguel eventually passes away, the business won’t be considered part of his estate for estate tax purposes, allowing the full value to pass to his children without estate taxes.  

6. When would you use a spousal lifetime access trust? 

A spousal lifetime access trust (SLAT) is a type of irrevocable trust created by one spouse for the benefit of the other spouse. Typically, a SLAT is used to remove assets from the couple’s taxable estate while ensuring they still have access to the assets during their lifetime. 

SLAT example scenario

Alexander and Janae are a married couple in their mid-fifties with three children. Janae owns a successful business and significant other investments, and the couple has a combined net worth of $25 million. Alexander and Janae are worried about the exemption sunset slated for 2026, and want to come up with a plan that will shield their future heirs from estate tax liability while allowing them to maintain access to their assets during their lifetimes if needed. 

This leads Janae to create a spousal lifetime access trust (SLAT) with Alexander as the beneficiary. She transfers $12 million of her assets into the SLAT, removing them from her taxable estate. By funding the SLAT, Janae uses the majority of her lifetime gift tax exemption. If the gift tax exemption rate decreases in the future, she has locked in the current higher exemption.

Since Alexander is the primary beneficiary of the SLAT, he can receive distributions from the trust as needed. This provides the couple with the security of knowing they can access their funds if needed (with Janae having indirect access through Alexander), and ensures Alexander is provided for financially if something happens to Janae. 

The SLAT is structured so that, after both spouses have passed away, the funds pass to their children.

The information provided here does not constitute legal, financial, or tax advice. It is provided for general informational purposes only. This information may not be updated or reflect changes in law. Please consult with an estate attorney, financial advisor, or tax professional who can advise as to your particular situation.