As much as we might like it to, Estate Planning doesn’t end when you create a Last Will and Testament. Often these documents need to be updated every three to five years, or supplemented with a Trust. These additional steps are especially important for those who have children, a home, or assets over $160,000. The creation of a Trust can help designate how these assets are handled after your death, and add an extra level of protection for your loved ones.
There are numerous types of Trusts available. For example, if you are married, the creation of an AB Trust may be the best route. These Trusts can help bypass hefty estate taxes in the event one spouse passes away first, though they are not for everyone. Keep reading to learn about:
What is an AB Trust?
An AB Trust is a Trust created by married couples to help minimize estate taxes for the surviving spouse after one spouse passes away. This joint Trust allows the estate to be split into two parts (or Trusts) after the death of a spouse, and then be taxed accordingly. The purpose of AB Trusts is to help avoid double taxation and ensure that your assets transfer to the right beneficiary, usually your spouse, after death.
How Does an AB Trust Work?
An AB Trust works by splitting a married couple’s assets into two separate Trusts, referred to as A and B. This distinction is established during the AB Trust set up when the couple writes a Last Will and Testament or creates a Living Trust. At that time, couples will divide their assets in equal parts to put into each Trust (as leaving them in joint accounts will void the AB Trust).
Looking at an AB Trust example can help illustrate this process: after the first spouse dies, the assets in A Trust will go to the surviving spouse. At the same time, the assets in B Trust will be subject to estate taxes. The surviving spouse will still have access to the income or assets left in B Trust after taxation, if those terms were specified when the Trust was created. Once the last spouse dies, only the assets in A Trust will be subject to estate taxes -- thus avoiding double taxation.
Commonly Asked Questions about AB Trusts
AB Trusts can be tricky to fully comprehend, as they dive into the minutiae of Estate Planning law. The following commonly asked questions should help further your understanding of AB Trusts and allow you to determine if this option is right for you and your spouse:
Are AB Trusts Obsolete?
AB Trusts are not entirely obsolete, though they are much less useful than they once were because of changes in estate law over time. AB Trusts were initially created to reduce estate taxes between married couples; however, currently each individual has a lifetime federal gift tax and estate tax exemption of up to $11.58 million.
Is an AB Trust Irrevocable?
An AB Trust is revocable until one spouse in a married couple dies. At that point, part of the assets are put into a revocable Trust for the surviving spouse; while the other portion goes into an irrevocable Trust on behalf of the deceased spouse. The A portion of the AB Trust is the revocable part for the spouse and the B portion is the irrevocable part.
What is the Difference between a Marital Trust and a Bypass Trust?
Once an AB Trust goes into effect, it transforms into both a marital Trust and a bypass Trust. The Marital Trust is another name for the Trust being left to the surviving spouse. A Bypass Trust is the name of the Trust by the deceased spouse, it is sometimes also known as a Family Trust or Credit Shelter Trust.
What are the Pros and Cons of AB Trusts?
AB Trust Estate Planning can be most beneficial for couples who live in a state without a portability for exemptions. Essentially, an AB Trust could help these individuals avoid state estate taxes. AB Trusts can also help ensure your beneficiaries are not changed by your spouse after your death. Similarly, these trusts can help designate where certain assets will go if you need to protect them from your spouse for whatever reason.
For the most part, estate law has evolved enough to prevent the need for an AB trust if your intention is to prevent double taxation. AB Trusts can be challenging for couples as the deceased spouse’s assets are put into an irrevocable Trust. This can limit the flexibility and freedom available to the surviving spouse.
The creation of a Trust can provide you with more control over your assets and help with your Estate Planning process. An AB Trust is one of the many options available to married couples — and is something worth considering for those who live in a state without certain exemptions. AB Trusts can be a great way to guarantee your beneficiaries and provide support to your spouse after death. If there is a question we didn’t answer, Reach out to us today or Chat with a live member support representative!
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FAQs
An AB Trust is a Trust created by married couples to help minimize estate taxes for the surviving spouse after one spouse passes away. This joint Trust allows the estate to be split into two parts (or Trusts) after the death of a spouse, and then be taxed accordingly.
What is the downside of an AB trust? ›
The benefits of an A-B trust include death tax exemptions, built-in trust protection, and the portability of exemption. Disadvantages include maintenance costs, complex structure, and the possibility of large capital gains taxes after both parties die.
What is an example of an ab trust? ›
Here's an AB trust example. John and Mary are married and set up an AB living trust. If John dies first, his share of the trust turns into a living irrevocable trust. Mary is allowed to access the income from the trust during her life, but not the principal.
What is the 5 by 5 rule in trust? ›
A "5 by 5 Power in Trust" is a common clause in many trusts that allows the trust's beneficiary to make certain withdrawals. Also also called a "5 by 5 Clause," it gives the beneficiary the ability to withdraw the greater of: $5,000 or. 5% of the trust's fair market value (FMV) from the trust each year.
What is an example of a disclaimer trust? ›
Disclaimer Trust Example
John and Mary set up an estate plan that includes a disclaimer trust. Upon John's death, Mary inherits all his assets. Still, she disclaims $5 million worth of investment assets to avoid estate taxes and preserve their wealth for their children and future grandchildren.
What is better than an AB trust? ›
An ABC trust, also known as a marital deduction trust, is similar to an AB trust in that it aims to maximize the estate tax exemption of both spouses. However, with an ABC trust, the surviving spouse can access the assets in the deceased spouse's trust more flexibly.
When a spouse dies, what happens with the trust? ›
Under typical circ*mstances, the surviving spouse would become the sole trustee after the death of one spouse. The surviving spouse would control the shared property, and the personal property of the deceased spouse would be distributed to the beneficiaries.
What happens to a joint irrevocable trust when one spouse dies? ›
Joint Trusts
Generally, both spouses serve as co-grantors and co-trustees, determining the trust terms and managing the trust together. When one spouse dies, the trust converts from a joint trust to an individual trust. As such, your spouse would have complete decision-making power.
What is the difference between a QTIP trust and an AB trust? ›
In its most basic form, a QTIP trust is essentially an A/B trust arrangement that is more restrictive than a typical marital trust. In most A/B trust arrangements, the marital, or A portion of the trust, is fully accessible by the surviving spouse.
Can AB trust be changed by surviving spouse? ›
An existing "B" or Bypass Trust can be modified to prevent this harsh result and the higher capital gains income taxes. However, you must act before the surviving spouse dies. The Bypass Trust can be modified during the surviving spouse's life despite the fact that the Trust is otherwise irrevocable.
After the Trust is written and established, the Trustee holds the power to administer the Trust as it is written. The Trustee has to follow the rules written within the Trust. Some Trusts can be revoked or changed after they've been established.
What is the 10% rule for trusts? ›
At the end of the day, this rule makes it so that you must donate at least 10 percent of the fund to the charity of your choice at the end of the trust term (whether that means years or decades down the road). Let's take a look at a real-life example of how the 10 percent rule plays out.
What is the maximum trust value that can be given? ›
However, the general rule of thumb is that owning assets that collectively total $100,000 or more constitutes a trust rather than a will. Of note, the complexity of your trust may determine how much it may cost you to set it up. That said, there is no enforced limit to the amount of money that can be placed in a trust.
What is the difference between a disclaimer trust and an AB trust? ›
A Disclaimer Trust permits a voluntary division into two sub-trusts if the surviving spouse thinks it is in the best interest of the beneficiary. However, an A-B trust generally contains compulsory language for the division.
What is the downside of a disclaimer trust? ›
CON: The surviving spouse needs to be mindful of the nine-month deadline to execute a disclaimer as well as the requirement that for a disclaimer to apply to assets, the surviving spouse should not exercise any powers over the assets intended to be disclaimed.
What is a Q tip trust? ›
What Is a Qualified Terminable Interest Property (QTIP) Trust? A qualified terminable interest property (QTIP) trust is a legal document that protects an individual's assets on behalf of the surviving spouse while maintaining control over how the assets are distributed once the surviving spouse dies.
What is the main risk of a unit trust? ›
Market Risk
This is the risk that investors' investment in the unit trust fund may not grow or generate income at a rate that keeps pace with inflation. This would reduce investors' purchasing power even though the value of the investment in monetary terms has increased.
What are the advantages and disadvantages of unit trust? ›
The unit trust's advantages and disadvantages are listed below.
- Liability. A unit trust minimises liability. ...
- Investment. A unit trust can attract a certain kind of investment. ...
- Loans. Unit trusts are taxed at the highest marginal income tax rate. ...
- Tax Planning. A unit trust does not have to pay tax.
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.
What is the primary disadvantage of irrevocable trust? ›
The downside of irrevocable trust is that you can't change it. And you can't act as your own trustee either. Once the trust is set up and the assets are transferred, you no longer have control over them, which can be a huge danger if you aren't confident about the reason you're setting up the trust to begin with.
