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 What is an AB Trust?

An AB trust, or A-B trust, is a special type of joint trust created by a married couple. Its main purpose is to minimize the taxes that must be paid on an estate when a person dies, and their property is transferred to someone else.

With an AB trust, when the first spouse dies, the trust transforms into two trusts: an irrevocable living trust in the deceased spouse’s name and a revocable living trust in the survivor’s name. Here’s an example. Scott and Jennifer are married and set up an AB living trust. When one of the spouses dies, the trust splits from one trust into two.

The deceased person’s trust (Trust A) turns into a living irrevocable trust. (In this circumstance, ‘irrevocable” means that the beneficiary(ies) cannot be changed.) Survivors can access the income from Trust A during their lifetime, but they cannot access the principal.

While it may seem that the benefits to the survivor are limited, there are still some advantages:

  • The surviving spouse can still live in the marital home.
  • The surviving spouse can still draw income from Trust A
  • When the surviving spouse passes away, only the assets in their “B” trust will be subject to estate taxation
  • They are not completely excluded from the principal in the trust. They may spend the trust property in any amount for their health, education, support, and maintenance in their accustomed manner of living.

During the survivor’s lifetime, their portion of the original trust, which is now Trust B, can be accessed (both the income and principal), and they can make any changes they want to the beneficiaries of Trust B. Upon the death of the survivor, both trusts will be emptied and distributed to whoever each person chose as their beneficiaries.

One useful advantage of an AB trust is that either or both parties can set it up so that there are no fights over the estate’s assets between one spouse and their children and the other spouse’s children from a prior relationship. As an example, Husband can name his beneficiaries his own children.

During Wife’s lifetime, she can access the trust income but not the principal. This allows the husband to provide for his wife after his death (from the income from the trust) but also preserves the assets themselves for Husband’s children. When the wife dies, Husband’s children will receive the principal from their father’s trust.

Also, if you want to preserve your portion of the estate because you fear your spouse would spend it unwisely, an AB trust will allow you to do that.

How Do I Create an AB Trust?

When setting up an AB trust (also known as a “living trust with marital life estate”), each spouse will name the final beneficiaries who will receive the trust’s property when the surviving spouse dies.

It is common for the spouses to name the same people, such as their children, as final beneficiaries. However, this is not mandatory. Just remember to set up the surviving spouse as the recipient of the trust property from the AB trust so that legal ownership never fully occurs during the spouse’s life.

AB Trusts and Federal Estate Tax

The original purpose of AB trusts was to reduce federal estate tax. If a couple does not have a trust and has $6 million in assets ($3 million each), the surviving spouse’s estate is now worth the full $6 million when the first spouse dies without a trust. (No estate tax had to be paid when the first spouse died because there is an exemption in the tax code for estates passing between spouses (the “marital exemption.”)

When the second spouse dies, the entire $6 million is in their estate, and taxes are applied, lessening the estate’s value.

On the other hand, If they use a trust, the first spouse’s assets are never owned by the other spouse (remember, they are held in trust for the first spouse’s beneficiaries), and so those assets are not taxed as part of the survivor’s estate upon their death. When the second spouse dies, the estate is only worth $3 million; if the federal estate tax is applied, that is the only portion that can be taxed. This can reduce the amount of the total tax by 50% or more.

How Tax Law Has Changed?

While AB trusts were a great way to reduce estate taxes when they were created, they are less useful. Each person has a combined lifetime federal gift tax and estate tax exemption of $5.43 million. This means no tax is applied to an estate valued at less than $5.43 million, which frees many families from worrying about an estate tax.

Moreover, there is also what is now called a portability provision. One spouse’s estate tax exemption passes to the surviving spouse. When the surviving spouse dies, they can use their own estate tax exemption of $5.43 million and sometimes also the first spouse’s $5.43 million exemption, allowing them up to $10.86 million in property that can pass tax-free.

For more information on the tax benefits of an AB trust, speak to a qualified accountant or a tax lawyer with experience in estate planning.

Are there Situations Where I Would Not Want to Use an AB Trust?

There can be various situations where an AB trust might not be the ideal choice for a married couple. For instance, if one spouse is much older than the other, then saving on estate taxes might not be a priority, especially when one of the spouses is likely to live a considerable length of time beyond the death of the other spouse. Thus, it might not be worth going through the additional expenses and requirements of setting up AB trusts.

If there have been recent changes to the trust laws in your state, or if the laws are set to change in the near future, then you should factor this into your decision. It may be the case that you want to wait and see how the changes in the law might affect your rights concerning AB trusts and other trust types.

Another potential drawback of an AB trust is that since it does not allow the surviving spouse to draw on the principal, this can limit the options and financial resources available to the survivor. If they need that money, it is not available.

Moreover, there are ongoing legal costs involved with an AB trust. There are also recordkeeping requirements and tax filing requirements for the irrevocable trust.

Do I Need a Lawyer for Help with an AB Trust?

Administering an estate can be very complicated, especially if AB trusts are involved. You or the person appointed to administer the estate may have tax issues or legal questions that need to be answered by a local lawyer or tax professional.

An experienced trust lawyer in your area will know what to do and help guide you through the legal formalities of deciding whether an AB trust is in your best interests and, if so, will guide you through setting one up.

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