An A/B Trust is an estate planning tool that is designed to help married couples reduce or eliminate estate taxes while ensuring the financial security of the surviving spouse and the eventual distribution of assets to their heirs. The trust works by dividing the estate into two parts upon the death of the first spouse—an “A” trust (the Survivor’s Trust) and a “B” trust (the Bypass Trust or Credit Shelter Trust).
How an A/B Trust Works:
- Creation During Marriage:
- The A/B trust is created during the couple’s lifetime. When the first spouse dies, the assets of the estate are divided into two separate trusts:
- Trust A (Survivor’s Trust): Holds the surviving spouse’s share of the estate.
- Trust B (Bypass Trust/Credit Shelter Trust): Holds the deceased spouse’s share of the estate, up to the federal estate tax exemption amount.
- The A/B trust is created during the couple’s lifetime. When the first spouse dies, the assets of the estate are divided into two separate trusts:
- Bypass Trust (Trust B):
- The assets in the Bypass Trust are not subject to estate taxes upon the death of the first spouse. The surviving spouse can benefit from the Bypass Trust (e.g., by receiving income from it or using the assets for certain purposes like healthcare or education), but they do not own the assets outright. Upon the death of the surviving spouse, the assets in the Bypass Trust are passed to the final beneficiaries, usually the couple’s children.
- Survivor’s Trust (Trust A):
- The assets in the Survivor’s Trust remain under the control of the surviving spouse. These assets can be used or spent freely by the surviving spouse. However, upon the death of the surviving spouse, the remaining assets in the Survivor’s Trust will be subject to estate taxes if the total exceeds the estate tax exemption at that time.
Key Purposes of an A/B Trust:
- Minimizing Estate Taxes:
- By splitting the estate into two trusts, the assets in the Bypass Trust avoid estate taxes when the surviving spouse dies. This allows each spouse to take full advantage of the estate tax exemption (also called the Unified Credit), which can effectively double the amount of wealth passed on to heirs tax-free.
- Preserving the Estate for Heirs:
- The A/B Trust ensures that at least a portion of the estate (the Bypass Trust) is preserved for the heirs, regardless of what the surviving spouse does with their own share of the assets (Survivor’s Trust). This is especially important in blended families or situations where the surviving spouse might remarry.
- Providing for the Surviving Spouse:
- The surviving spouse can still benefit from the Bypass Trust without owning the assets. They may receive income from the trust or have access to trust assets for specific needs, depending on the terms of the trust.
Example:
- A couple has a total estate worth $10 million. The federal estate tax exemption is $5 million per person.
- When the first spouse dies, half the estate ($5 million) is placed in the Bypass Trust (Trust B), which is shielded from estate taxes and passes tax-free to the heirs upon the death of the surviving spouse.
- The remaining $5 million goes into the Survivor’s Trust (Trust A) and remains under the control of the surviving spouse. When the surviving spouse dies, any assets in the Survivor’s Trust above the estate tax exemption will be subject to estate tax.
By using the A/B Trust structure, the estate maximizes tax-free transfers to beneficiaries and minimizes the taxable estate of the surviving spouse.
Key Benefits of an A/B Trust:
- Maximizes Estate Tax Exemptions:
- Each spouse’s estate tax exemption is fully utilized, allowing more assets to pass to heirs tax-free.
- Protects the Interests of Heirs:
- Ensures that the assets placed in the Bypass Trust are preserved for the heirs, even if the surviving spouse remarries or has additional financial obligations.
- Financial Security for Surviving Spouse:
- The surviving spouse still has access to income or limited use of the Bypass Trust assets while having full control over their own assets in the Survivor’s Trust.
Potential Drawbacks of an A/B Trust:
- Complexity and Administration:
- After the first spouse’s death, the trust must be split into two separate trusts, which requires ongoing administration, record-keeping, and potential legal or accounting assistance.
- Irrevocable Bypass Trust:
- The assets in the Bypass Trust are generally irrevocable, meaning the surviving spouse cannot change beneficiaries or access principal beyond what is allowed in the trust agreement.
- Changing Estate Tax Laws:
- As estate tax exemption limits change over time, the need for an A/B Trust may become less relevant, especially with the introduction of portability, which allows a surviving spouse to inherit the unused portion of the deceased spouse’s estate tax exemption without the need for a Bypass Trust.
Conclusion:
An A/B Trust is an effective estate planning tool for married couples who want to minimize estate taxes and protect their wealth for future generations. While it provides both tax advantages and financial protection for the surviving spouse, it also involves complexities in terms of administration. Couples considering this type of trust should consult with an estate planning attorney to ensure that it aligns with their specific needs and estate tax planning goals.