AB Trusts: The Tax-Saver

In this article, learn more about how an AB trust can bring tremendous tax savings.

How an AB Trust Works

Spouses can set up an AB trust. You need to know how one works to decide whether or not this type of family trust is a good option for you. An AB trust not only helps your loved ones avoid probate court but also can avoid costly estate taxes for couples whose assets exceed the federal exemption amount. Given the current federal estate tax exemptions, gift taxes and estate taxes only apply to the wealthiest Americans.

An AB trust is a form of an irrevocable trust that comes in two parts.

Part I: Marital Trust

The first part of a marital trust, trust A, is a trust created when the first spouse dies. It is outlined by a will or as part of a living trust.

The decedent's separate property and share of community property transfer into the marital trust. This is to be used for the benefit of the surviving spouse. Due to the estate tax marital deduction, no estate tax is owed at the first spouse's death, as the first spouse used the estate tax exemption to transfer assets into the trust.

This initial part of the AB trust is used to:

• Benefit the surviving spouse
• Name the beneficiaries who will inherit property when the second spouse dies

The surviving spouse doesn't technically own the property. Thus, the property is not part of the surviving spouse's estate. The surviving spouse's use of the property is secured in the trust document as long as they meet the trust conditions.

For example, the surviving spouse has full use of the family home. They also can spend trust assets. You can learn more about that below.

Part II: Bypass Trust

When the second spouse dies, the B trust portion of the AB trust kicks in. This is the bypass trust. Trust B only applies when both spouses have passed away. All the AB trust's property transfers to the remaining beneficiaries. Usually, this means the couple's children.

Estate tax law allows the second spouse to use the estate tax exemption again to transfer the couple's assets. This is called the “portability provision."

Surviving Spouse's Rights Over the Assets

As discussed above, the AB trust gives the surviving spouse some power over the assets, depending on the trust's provisions. The surviving spouse's rights and benefits include:

• Receiving income from the trust property, including interest income
• Spending trust property to support and maintain their standard of living, health care, or education
• Use of real estate and other property

The surviving spouse maintains these rights until death. Then, when they die, all assets in the original AB trust are distributed to the final beneficiaries. All of the second spouse's property is distributed to their beneficiaries according to their will or trust.

Is an AB Trust Right for You?

An AB trust is best suited for someone who meets all these criteria:

• Married
• Over the age of 60
• Without children from any previous marriages

When there are children from prior relationships, it can cause conflicts. The surviving spouse and the deceased spouse's children may want a share of the trust's assets.

Disadvantages of an AB trust

There are several disadvantages to this type of trust. Be sure to work with an estate planning attorney whom you trust and who can provide sound legal advice. There may be other estate planning options for minimizing the tax consequences of transferring assets of the combined estate.

The potential disadvantages include:

• An AB trust begins as a revocable living trust, but once the first spouse dies it becomes an irrevocable trust. No changes can be made to an irrevocable trust.
• The surviving spouse's rights to use the property are limited. At one time, this may have been the marital home they shared with a beloved spouse. The surviving spouse could do as they pleased with the property, but now their use of the property has some restrictions. The home belongs to the children and not the spouse. The spouse only has temporary use of the home.
• An AB trust requires ongoing paperwork and bookkeeping duties. The surviving spouse needs a tax ID number and must file annual income tax returns on the trust. They must also keep records of all the assets in the deceased spouse's estate.
• Distributing the assets of an AB trust can be expensive and often requires a lawyer and an accountant. Furthermore, these tax laws change. Some changes may make you want to change or even revoke your AB trust.

Want To Learn More About AB Trusts? Talk to an Attorney

If an AB trust might suit your situation, talk to an estate planning lawyer about your specific circumstances and needs. The best way to determine if an AB trust is ideal for you is to understand your trust options, available estate tax exemption amounts, and IRS regulations. An experienced estate planning lawyer will be able to advise you.