Simona Ondrejkova, CFP

Feb 20, 2024

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What Is a Credit Shelter Trust? And How Can It Help Minimize Estate Taxes?

In estate planning, there are several types of trusts especially designed to help individuals avoid or reduce estate taxes. One of these is the credit shelter trust. The credit shelter trust is often used by married couples as one of many estate planning strategies that can help them pass on more wealth to beneficiaries after both spouses pass away.

Here, we explain what a credit shelter trust is, how it works, and when you or your clients should consider using it to leave a greater legacy by minimizing or even eliminating the estate tax bill.

What is a credit shelter trust?

A credit shelter trust, also known as a bypass trust or a family trust, is a type of trust designed to minimize federal estate taxes for married couples. The basic idea behind a credit shelter trust is to make full use of the estate and gift tax exemption for each individual in the couple. 

Through the use of the estate and gift tax exemption, the credit shelter trust essentially “shelters” the assets in the trust (and their future appreciation) from being included in the estate of the surviving spouse. This means that anything left in the trust upon the death of the second spouse can pass on to children, grandchildren, or other beneficiaries tax-free.

How does a credit shelter trust work?

A credit shelter trust is set up by one or both spouses during their lifetime with the help of an estate planning attorney or estate planning software. However, the trust does not take effect until after the first spouse in the couple dies. At this time, the trust also becomes irrevocable.

Upon the death of the first spouse, the credit shelter trust is funded with assets up to the deceased spouse’s available federal estate and gift tax exemption amount ($13.61 million per individual in 2024). 

The individual setting up the credit shelter trust (the settlor) appoints a trustee who will distribute the funds in the credit shelter trust based on the settlor’s wishes. While the surviving spouse does not have unlimited access to the trust principal, they are generally entitled to receive the income from the trust and may have limited powers to draw upon the principal for specific needs like health or education. 

Upon the death of the surviving spouse, any assets that remain in the trust pass on to the beneficiaries outlined in the trust without being subject to estate taxes. This is because the surviving spouse does not have full control over the distribution of the trust principal, which removes the assets from their estate.

When should married couples consider using a credit shelter trust?

Any married individuals who leave assets to a spouse can benefit from the unlimited marital tax deduction. This lets them pass on any amount to their spouse without it being subject to estate taxes upon the death of the first spouse.

Yet the unlimited marital tax deduction can only get married couples so far in protecting their wealth from estate taxes. If each spouse’s net worth is above the estate and gift tax exemption and they do not utilize any advanced estate planning strategies or portability, then it’s likely that at least a part of the estate will be taxable after the second spouse dies.

Therefore, married couples would want to leverage a credit shelter trust if they also wish to eliminate or minimize estate taxes due upon the death of the surviving spouse. The funding of the credit shelter trust removes those assets plus any subsequent appreciation on those assets from the surviving spouse’s taxable estate. Without proper estate planning, and, at a minimum, filing an estate tax return at the first spouse’s death to elect portability of their unused exemption, the estate of the surviving spouse may only have that surviving spouse’s estate tax exemption available.

The credit shelter trust is also sometimes called a unified credit trust because it allows an individual to use their estate tax unified credit to offset any estate taxes that might be due upon the death of the surviving spouse. This effectively allows a married couple to use the entire $27.22 million per couple(in 2024) estate tax exemption regardless of the amount of each spouse’s individual estate without having to file an estate tax return when the first spouse dies to elect portability.

Pros and cons of a credit shelter trust

The most significant benefit of using a credit shelter trust is that it allows spouses to use both of their estate tax exemptions to pass assets up to the exemption amount tax-free to future beneficiaries and it removes any appreciation on the assets that fund the credit shelter trust at first death from any future estate tax.

Unlike the portability election which must be made a timely filed estate tax return when the first spouse dies, even if one is otherwise not necessary to be filed, in order to  increase the estate tax exemption for the surviving spouse by the deceased spouse’s unused exemption amount, the credit shelter trust is automatically funded at the first spouse’s death up to their remaining federal exemption amount.  also shelters the appreciation of assets by removing them out of the surviving spouse’s estate.

Another benefit of a credit shelter trust is that it allows each spouse to specify how to distribute any assets remaining after the death of their spouse. This can be useful in the case of second marriages as the first spouse can intentionally protect their children’s assets from any potential future spouses if the surviving spouse remarries. 

Additionally, because the credit shelter trust is irrevocable and removes the assets from the surviving spouse’s estate, it also provides protection from creditors. Like other trusts, this type of trust also helps families avoid lengthy probate proceedings and protects family wealth in a way that’s aligned with the settlor’s wishes.

One of the disadvantages of a credit shelter trust is that it does not give the surviving spouse immediate access or full control over the trust assets. Instead, the spouse can generally receive income from the trust and may be allowed to use the trust principal to pay for health, education, and maintenance as needed.

What’s the difference between a credit shelter trust vs marital trust?

A credit shelter trust is often used along with a marital trust to utilize the AB Trust estate planning strategy. While similar to a credit shelter trust in that it provides income for a surviving spouse, a marital trust is different from a credit shelter trust in terms of how it affects the couple’s estate taxes.

Upon the death of the second spouse, any assets in a credit shelter trust are passed to the beneficiaries estate tax-free. This is because the trust was funded with assets up to the exemption amount and any growth in those assets gets to pass without being subject to estate taxes.

The marital trust is different, however. The marital trust is not taxed at first death because it is offset with the marital deduction. When the second spouse dies, the marital trust assets are included in the second spouse’s estate and may be subject to estate taxes depending on the amount of the second spouse’s remaining exemption. Unlike a credit shelter trust, assets in the marital trust plus any appreciation on those assets after the first spouse dies are counted as part of the second spouse’s estate.

In the AB Trust strategy, both trusts are used together to preserve the maximum wealth by reducing estate taxes to the minimum. The credit shelter trust (“Trust B”) is used to avoid estate taxes at first and second death by using the estate tax exemption of the first spouse to die while the marital trust (“Trust A”) takes advantage of the unlimited marital deduction to pass assets onto the spouse without estate tax at the first death.

Additional factors to consider with a credit shelter trust

The credit shelter trust is meant to help eliminate or reduce federal estate taxes. When doing estate planning, it’s also very important to consider state estate taxes. If you or your clients live in a state where the state estate tax exemption is less than the federal exemption, state-level estate taxes may still be due upon the death of the first spouse. This is why it’s best to consult an estate planning attorney in your state to determine whether a credit shelter trust will make sense for your situation. 

Depending on your state, the attorney may recommend funding the trust with an amount that only equates up to the state’s estate tax exemption amount.

With the 2026 estate and gift tax exemption sunset, the current $13.61 million per individual/$27.22 million per couple in 2024 estate tax exemption will be cut in half. This is why it’s important to plan ahead now, even if your net worth currently falls under the exemption amount.

Just getting started with estate planning? Use our estate planning checklist to help you gather the documents and information you need to help you or your clients leave a legacy in a manner that aligns with your wishes while minimizing taxes.