12 September, 2016
Barb scurries about the house taking care of last minute details, while Mike is in the garage pulling down the decorations. Barb and Mike have hosted many family gatherings in their 40 years of marriage, but this year will be a little different. Mike has been diagnosed with a terminal condition. They intend to make the announcement after the family arrives. Mike, at age 74, has long accepted that he can't take anything with him, and his first priority is to take care of Barb for the rest of her life. If anything is left, he would like to divide the rest of his assets between their children, equally. Before Mike reduces anything to writing, he wants to know more about the new portability option in estate planning. Mike, a retired investment advisor, is no stranger to financial and estate planning. In fact, he often advised his clients to get their affairs in order. The default recommendation - before portability - was to establish a credit shelter plan. He knows there is a great deal more flexibility now, but he doesn't completely understand the difference between a credit shelter and a portability plan. In short, one offers simplicity, the other, while more complicated, provides additional benefits.
Portability vs. a Credit Shelter Plan
How does Portability work?
A major advantage of current federal tax law is that estate tax exemption "portability" is now permanent. Portability simplifies estate planning by allowing a surviving spouse to use the deceased spouse's unused portion of the $5.45 million (for 2016) gift and estate tax exemption amount. The surviving spouse can use that amount, in addition to his or her own exemption, to make tax-free transfers during lifetime or at death. Married couples can maximize the benefits of their combined exemptions without the need for sophisticated estate planning involving multiple trusts. Although portability is relatively simple, it has precise parameters. First, portability isn't automatic. The executor of the deceased spouse's estate must make an election on a timely filed estate tax return - even if a return wouldn't otherwise be required. Also, special rules apply to surviving spouses who are predeceased by more than one spouse. Additionally, if your estate plan includes bequests to grandchildren, the generation-skipping transfer tax exemption isn't covered by the portability provision.
Benefits of a Credit Shelter Plan
While portability may have a few complexities, it's still simpler than a credit shelter plan, which may employ either a usufruct (in Louisiana) or a credit shelter trust (sometimes referred to as a "bypass" trust). Nevertheless, creating such a credit shelter plan can be a better alternative. Why? Because a credit shelter plan offers a major advantage over portability: It can protect future appreciation on the trust's assets from estate taxes. If you and your spouse have estates that exceed the combined exemption amount threshold ($10.9 million in 2016) or may have estates that exceed the limit at some point in the future, a credit shelter plan remains the most effective strategy for minimizing estate taxes. On the first spouse's death, when assets are placed in a credit shelter trust or are subject to a lifetime usufruct (with proper elections), their value is frozen for estate tax purposes. This means that any future appreciation on those assets bypasses your surviving spouse's estate. But if you rely on portability, future appreciation will be included in your spouse's estate. This could trigger significant estate tax liability. Even if you and your spouse's combined estate is unlikely to ever exceed your combined exemption, credit shelter planning offers important benefits such as: Asset protection. Portability allows you to leave your wealth to your spouse outright without wasting your estate tax exemption. But it does nothing to protect those assets from your spouse's creditors or financial mismanagement. Well-designed and managed credit shelter trusts remain the most effective way to protect your assets and preserve them for future generations. Remarriage protection. Proper credit shelter planning ensures that your children are provided for, even if your spouse remarries. A credit shelter trust (or properly optimized usufruct) can prevent your spouse from spending your children's inheritance on his or her new spouse or on children from the subsequent marriage. It also avoids the potential loss of portability benefits in the event your spouse's new spouse dies. Portability is available only for a person's most recently deceased spouse. If your spouse remarries and his or her new spouse dies, portability will be limited to the new spouse's unused exemption - which could be little or nothing. Generation-skipping transfer (GST) tax planning. The GST tax exemption ($5.43 million this year) is not portable. If you and your spouse wish to maximize your GST exemptions for bequests to your grandchildren, you'll have another reason to consider trusts.
Portability has the benefit of simplicity, but before you rely on it, review your situation and consider whether you'd be better off with a credit shelter plan. As with most life decisions, careful planning benefits all of the parties involved. Peace of mind can be just as valuable as bequests and legacies.
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