An A/B Trust is an estate planning strategy commonly used by married couples to minimize estate taxes and ensure the financial security of the surviving spouse, while also preserving wealth for heirs. This type of trust essentially splits the estate into two separate trusts upon the death of the first spouse: Trust A (also known as the Survivor’s Trust) and Trust B (known as the Bypass Trust or Credit Shelter Trust).
How an A/B Trust Works:
- Trust A (Survivor’s Trust):
- Contains the surviving spouse’s portion of the estate.
- The surviving spouse has full control over the assets in this trust, which they can use, modify, or spend as needed.
- The assets in this trust will be subject to estate taxes upon the death of the surviving spouse, based on the federal estate tax exemption in place at the time.
- Trust B (Bypass Trust/Credit Shelter Trust):
- Holds the deceased spouse’s portion of the estate, up to the federal estate tax exemption limit (currently $12.92 million per individual in 2023).
- The assets in Trust B bypass the estate of the surviving spouse and are not subject to estate taxes upon the surviving spouse’s death.
- The surviving spouse may have limited access to the income from this trust but cannot control or alter the principal. This protects the assets for the couple’s heirs, often the children.
- Upon the death of the surviving spouse, the assets in Trust B are passed to the beneficiaries (typically the children) without incurring estate taxes.
Key Benefits:
- Tax Minimization: By splitting the estate, the couple can use both spouses’ estate tax exemptions, effectively doubling the amount that can be passed to heirs tax-free.
- Asset Protection: The Bypass Trust ensures that the deceased spouse’s portion of the estate is protected from being depleted or altered by the surviving spouse, preserving it for the intended heirs.
- Financial Security: The Survivor’s Trust ensures the surviving spouse can maintain their standard of living, while the Bypass Trust preserves wealth for heirs.
Example:
- A couple has a total estate worth $15 million. When the first spouse dies, the estate is split into two trusts:
- Trust A (Survivor’s Trust) might hold $7 million, fully accessible to the surviving spouse.
- Trust B (Bypass Trust) holds $8 million, which is protected from estate taxes upon the surviving spouse’s death.
By using an A/B Trust, the couple can shield the $8 million in Trust B from estate taxes, potentially saving millions in taxes while still providing for the surviving spouse.
Considerations:
- Estate Size: A/B Trusts are most beneficial for couples with estates large enough to exceed the federal estate tax exemption.
- Complexity: These trusts require ongoing management and accounting, particularly after the death of the first spouse.
Conclusion:
An A/B Trust is a valuable estate planning tool for reducing estate taxes, protecting assets, and ensuring financial security for both the surviving spouse and heirs. However, it’s best suited for larger estates and should be implemented with the help of an estate planning attorney.