AB Trusts Explained: The Tax-Saver

Share this post on social media

AB trusts are a popular estate planning tool used by married couples to reduce or avoid federal estate taxes.

Please note that the free advice provided on our platform is for informational purposes only and not legally binding. View our legal disclaimer here. 

Also any or all of the links on this website are affiliate links of which Freelegaladvice.io receives a small commission from sales of certain items, but the price is the same for you. View our affiliate disclaimer here

Table of Contents

AB trusts are a popular estate planning tool used by married couples to reduce or avoid federal estate taxes. Essentially, an AB trust is a joint trust created by a married couple that is split into two separate trusts upon one spouse’s death. The surviving spouse retains control over the assets in the A trust, while the assets in the B trust are transferred to the couple’s beneficiaries.

The tax benefits of AB trusts are significant. By splitting assets into two trusts, each spouse can take advantage of the estate tax exemption, effectively doubling the amount of assets that can be passed on tax-free to beneficiaries. Additionally, assets in the B trust are not subject to estate tax upon the surviving spouse’s death, which can result in significant tax savings for the couple’s heirs.

Related Post: What is estate planning? The Ultimate Guide.

Key Takeaways

  • AB trusts are an estate planning tool used by married couples to reduce or avoid federal estate taxes.
  • By splitting assets into two trusts, each spouse can take advantage of the estate tax exemption, effectively doubling the amount of assets that can be passed on tax-free to beneficiaries.
  • Assets in the B trust are not subject to estate tax upon the surviving spouse’s death, which can result in significant tax savings for the couple’s heirs.

Understanding AB Trusts

AB Trusts, also known as bypass trusts or credit shelter trusts, are a popular estate planning tool for married couples looking to minimize estate taxes. The basic idea behind an AB Trust is to split a couple’s assets into two separate trusts upon the death of the first spouse, with each trust serving a different purpose.

The A Trust, also known as the survivor’s trust, is designed to provide income and support to the surviving spouse. The B Trust, also known as the bypass trust, is designed to shelter the assets of the deceased spouse from estate taxes.

The A Trust is typically a revocable trust, meaning that the surviving spouse has the power to change or revoke it at any time. The B Trust, on the other hand, is typically an irrevocable trust, meaning that it cannot be changed or revoked once it is created.

One of the key benefits of an AB Trust is that it allows a married couple to take advantage of both spouses’ estate tax exemptions. Under current law, each individual is entitled to a certain amount of assets that can be passed on to their heirs tax-free. By splitting their assets into two separate trusts, a married couple can effectively double the amount of assets that can be passed on tax-free.

It is important to note that AB Trusts are not for everyone. They are typically most beneficial for couples with significant assets who are concerned about estate taxes. Additionally, AB Trusts can be complex and require careful planning and execution. It is important to work with an experienced estate planning attorney to ensure that an AB Trust is the right choice for your specific situation.

Tax Benefits of AB Trusts

AB Trusts provide several tax benefits for married couples who want to minimize estate taxes. Here are two of the most significant tax benefits of AB Trusts:

Estate Tax Exemption

One of the most significant tax benefits of AB Trusts is that they allow a married couple to take advantage of both of their estate tax exemptions. Each spouse can use their own estate tax exemption to shelter assets from estate taxes, effectively doubling the amount of assets that can be passed on to heirs tax-free.

As of 2023, the federal estate tax exemption is $12.06 million per individual, which means that a married couple can pass on up to $24.12 million tax-free with proper estate planning. However, without an AB Trust, a married couple would only be able to pass on up to $12.06 million tax-free.

Gift Tax Exemption

AB Trusts also provide gift tax benefits for married couples. When one spouse dies, their assets are transferred to the bypass trust, which is not subject to estate taxes. The surviving spouse can then use their own estate tax exemption to transfer assets to the bypass trust tax-free.

This means that the surviving spouse can effectively give twice as much to their heirs without incurring gift taxes. As of 2023, the annual gift tax exclusion is $16,000 per recipient, which means that a married couple can give up to $32,000 per recipient tax-free.

Overall, AB Trusts provide significant tax benefits for married couples who want to minimize estate taxes and maximize the amount of assets they can pass on to their heirs tax-free. By taking advantage of both estate tax exemptions and gift tax exclusions, married couples can effectively double the amount of assets they can transfer tax-free.

Setting up an AB Trust

An AB Trust is an estate planning device that can help married couples minimize estate taxes. To set up an AB Trust, the couple must meet certain legal requirements and follow a specific process and timeline.

Legal Requirements

To establish an AB Trust, the couple must be legally married, and each spouse must have a revocable living trust. The trust documents must contain specific language that creates the AB Trust structure, which includes two separate trusts: the A Trust and the B Trust.

The A Trust is also known as the “marital trust” or “survivor’s trust,” and it is designed to hold assets for the surviving spouse’s benefit. The B Trust is also known as the “bypass trust” or “credit shelter trust,” and it is designed to hold assets for the benefit of the couple’s heirs.

The couple must also ensure that the total value of their assets does not exceed the federal estate tax exemption limit. In 2023, the federal estate tax exemption limit is $12.06 million per individual, which means that a married couple can pass on up to $24.12 million in assets without incurring federal estate taxes.

Process and Timeline

The process of setting up an AB Trust typically involves the following steps:

  1. Review and update existing estate planning documents, including wills, trusts, and powers of attorney, to ensure that they are consistent with the AB Trust structure.
  2. Work with an experienced estate planning attorney to draft new trust documents that include the necessary language to establish the A and B Trusts.
  3. Fund the A and B Trusts by transferring assets into each trust according to the terms of the trust documents.
  4. Review and update the AB Trust regularly to ensure that it remains consistent with the couple’s estate planning goals and objectives.

The timeline for setting up an AB Trust can vary depending on the complexity of the couple’s estate plan and the availability of the attorney and other professionals involved. However, it is important to start the process as early as possible to ensure that the AB Trust is in place before it is needed.

In conclusion, setting up an AB Trust requires careful planning and execution to ensure that the couple’s estate planning goals are achieved. By meeting the legal requirements and following the process and timeline, married couples can use an AB Trust to minimize estate taxes and preserve their wealth for future generations.

Managing an AB Trust

An AB Trust is a type of trust that can help married couples minimize estate taxes. However, managing an AB Trust can be a complex process that requires careful attention to detail. In this section, we’ll discuss the duties of trustees and the basics of trust administration.

Duties of Trustees

The trustees of an AB Trust have several important duties, including:

  • Managing Trust Assets: Trustees are responsible for managing the assets held in the trust. This includes investing the assets and making sure they are properly maintained.
  • Filing Tax Returns: Trustees are also responsible for filing tax returns on behalf of the trust. This includes income tax returns and estate tax returns.
  • Distributing Trust Assets: When the first spouse dies, the assets in the trust are split into two separate trusts. The surviving spouse is typically the beneficiary of both trusts. However, the trustees must ensure that the assets are distributed in accordance with the terms of the trust.

Trust Administration

Trust administration involves managing the day-to-day operations of the trust. This includes:

  • Keeping Accurate Records: Trustees must keep accurate records of all trust transactions. This includes keeping track of income and expenses, as well as any distributions made to beneficiaries.
  • Communicating with Beneficiaries: Trustees must communicate with the beneficiaries of the trust and keep them informed about the status of the trust.
  • Meeting Legal Requirements: Trustees must ensure that the trust is in compliance with all legal requirements. This includes filing tax returns and adhering to the terms of the trust.

Overall, managing an AB Trust can be a complex process that requires careful attention to detail. However, with the help of a knowledgeable attorney and a qualified trustee, it is possible to successfully manage an AB Trust and minimize estate taxes for married couples.

Potential Drawbacks of AB Trusts

While AB trusts can be an effective way to save on estate taxes, they are not without potential drawbacks. In this section, we will explore some of the potential drawbacks of AB trusts.

Limited Access to Assets

One potential drawback of AB trusts is that they can limit the surviving spouse’s access to assets. Under an AB trust, the surviving spouse only has access to the assets in the A trust, not the assets in the B trust. This can be problematic if the surviving spouse needs access to the assets in the B trust for any reason.

Complexity and Costs

Another potential drawback of AB trusts is that they can be complex and costly to set up and maintain. AB trusts require separate tax returns, and the trustee must keep track of which assets are in which trust. This can be time-consuming and expensive, especially if the estate is large or complex.

In addition, AB trusts may require the services of an attorney, accountant, or financial advisor to set up and maintain. These professionals can be expensive, and the costs can add up over time.

Overall, while AB trusts can be an effective way to save on estate taxes, they are not without potential drawbacks. Individuals considering an AB trust should carefully weigh the potential benefits and drawbacks before deciding whether an AB trust is right for them.

Frequently Asked Questions

What are the disadvantages of AB trusts?

AB trusts may not be suitable for everyone. One disadvantage is that they can be complex and expensive to set up, which may not be worth it for smaller estates. Additionally, AB trusts may not be necessary for couples who are not concerned about estate taxes or who live in states that do not have an estate tax.

Are AB trusts obsolete?

AB trusts are not obsolete, but they may not be as common as they once were. This is due in part to changes in federal estate tax laws that have increased the amount of money that can be transferred without incurring estate tax. However, AB trusts can still be useful for some couples, particularly those with larger estates.

Can a surviving spouse change an AB trust?

In most cases, a surviving spouse cannot change an AB trust. This is because the trust is typically irrevocable after the death of the first spouse. However, the surviving spouse may have some control over the trust assets, depending on how the trust is structured.

Does an AB trust receive a step-up in basis?

Yes, an AB trust can receive a step-up in basis. This means that the value of the assets in the trust is adjusted to reflect their fair market value at the time of the second spouse’s death. This can be beneficial for the beneficiaries of the trust, as it can reduce the amount of capital gains tax they may owe if they sell the assets.

How does a two-trust plan alleviate tax burdens?

A two-trust plan, which includes both an A trust and a B trust, can help alleviate tax burdens by allowing each spouse to take advantage of their individual estate tax exemptions. This can result in significant tax savings for couples with larger estates.

What are the differences between AB trusts and A trusts?

The primary difference between AB trusts and A trusts is that AB trusts are designed to minimize estate taxes for married couples, while A trusts are designed to provide asset protection and control for the surviving spouse. Additionally, AB trusts are split into two parts after the death of the first spouse, while A trusts remain intact.

About the author

Manuel has been a paralegal expert for more than 15 years and works for one of the largest law firm in the state of New York.

Recent Posts

Scroll to Top