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A-B Trust

Definition

An A-B Trust, also known as a credit shelter trust, is an estate planning strategy used by married couples to reduce or eliminate federal estate taxes upon the death of the first spouse. The trust divides the couple’s assets into two separate components, one under the deceased spouse (Trust B) and another under the surviving spouse (Trust A). This structure allows the couple to maximize their individual estate tax exemptions, thus preserving more wealth for their beneficiaries.

Phonetic

The phonetics of the keyword “A-B Trust” can be represented as follows:A: /ˈeɪ/B: /ˈbi/Trust: /trəst/When spoken, it would sound like “Ay-Bee Trust”.

Key Takeaways

 

  1. Tax Minimization: A-B Trusts are primarily utilized by married couples to reduce or eliminate federal estate taxes upon the death of the first spouse, thereby preserving the maximum amount of assets for the surviving spouse and their heirs.
  2. Asset Protection: An A-B Trust can offer enhanced asset protection for the surviving spouse and beneficiaries, as assets placed in the trust may be shielded from the claims of creditors and in some cases, from future spouses in the event of remarriage.
  3. Control Over Distribution of Assets: By establishing an A-B Trust, the grantor can ensure that their assets are distributed according to their wishes, even after their passing. This includes providing ongoing financial support for the surviving spouse, while also ensuring that remaining assets are distributed to designated beneficiaries, such as children or other family members, after the death of the surviving spouse.

 

Importance

An A-B Trust, also known as a marital or bypass trust, is vital in estate planning as it helps in reducing estate taxes and protecting assets for beneficiaries. This type of trust allows a married couple to divide their estate into two parts:

Trust A, containing assets up to the federal estate tax exemption limit, and Trust B, which holds assets exceeding that limit. Upon the death of the first spouse, Trust A, also known as the Survivor’s Trust, provides assets to the surviving spouse without incurring estate taxes while maintaining their usage rights.

Trust B, called the Bypass or Family Trust, holds the remaining assets for the intended beneficiaries, often children or grandchildren, and benefits from estate tax exemptions for future generations. Thus, the A-B trust setup is vital for minimizing estate tax liabilities, efficiently transferring wealth to heirs, and ensuring the financial well-being of the family.

Explanation

The primary purpose of an A-B Trust, also known as a marital trust, lies in its ability to minimize estate taxes upon the death of a spouse, whilst ensuring the financial well-being of the surviving spouse and ultimately passing on the assets to the designated beneficiaries. It serves as a valuable estate planning tool for married couples who want to maximize the tax benefits available from the transfer of their assets.

Often used by couples with significant wealth, an A-B Trust creates a legal framework that facilitates the strategic distribution of assets between spouses and their heirs, ensuring that the money and property are handled in a tax-efficient manner.

When one spouse passes away, the A-B Trust splits into two separate trusts, namely Trust A and Trust B. Trust A, or the surviving spouse’s trust, grants the surviving spouse access to the income and principal of the trust, according to the terms of the trust. Trust B, also known as the decedent’s or bypass trust, holds the assets of the deceased spouse.

This decedent’s trust is designed in such a way that it utilizes the federal estate tax exemption – avoiding estate taxes on the deceased spouse’s estate. The surviving spouse, though does not directly own the assets of Trust B, can still benefit from them during their lifetime, as the trust may permit access to the income or principal under certain circumstances. Upon the death of the surviving spouse, the assets from both trusts are then distributed to the predetermined beneficiaries, reducing the overall estate tax liability and ensuring that the couple’s financial legacy is managed according to their wishes.

Examples

An A-B trust, also known as a credit shelter trust or bypass trust, is an estate planning tool used by married couples to minimize estate taxes and ensure that assets are passed on to their intended beneficiaries. Here are three real-world examples:

1. John and Jane SmithJohn and Jane Smith have a combined estate worth $20 million, which includes their home, investments, and other assets. They are aware that the estate tax exemption for individual estates is currently $11.7 million (as of 2021). To minimize estate taxes, they create an A-B trust.

When John passes away, his share of the estate ($10 million) is transferred into the “B” trust or bypass trust. This trust is designed to provide Jane (the surviving spouse) with income and access to the principal if needed, without adding the value of the trust to her estate. When Jane dies, the assets of the “B” trust are distributed to their children, and since the “B” trust is not part of Jane’s estate, it is not subject to estate taxes.

Meanwhile, Jane’s own estate (‘A’ trust or marital trust) remains under the estate tax exemption limit and is also distributed to their children without any estate tax liability. This way, the couple effectively shields $20 million from estate taxes through the use of the A-B trust.

2. Tom and Mary JohnsonTom and Mary Johnson have a combined estate worth $5 million, and they both have children from previous marriages. They decide to create an A-B trust to ensure that their respective children receive an inheritance, while still providing financial support for the surviving spouse.

When Tom dies, his portion of the estate is transferred into the “B” trust. Mary, as the surviving spouse, will receive income from the trust, but she cannot change the trust beneficiaries or access the trust’s principal. After Mary’s death, the assets in the “B” trust are distributed to Tom’s children as per his wishes. Mary’s estate, part of the “A” trust, will similarly be passed on to her children when she passes away.

3. Robert and Elizabeth Taylor Robert and Elizabeth Taylor have a combined estate worth $25 million. Their two adult children both have substantial wealth, so they decide to leave a significant portion of their estate to various charitable organizations. To achieve this goal, they create an A-B trust with a charitable remainder component.

When Robert passes away, his share of the estate goes into the “B” trust and provides income for Elizabeth during her lifetime. After Elizabeth’s death, the remaining trust assets are distributed to the designated charities, providing a significant charitable gift while also reducing their estate tax liability.

Frequently Asked Questions(FAQ)

What is an A-B Trust?

An A-B Trust is a common estate planning arrangement where a married couple creates two distinct trusts called the ‘A Trust’ and the ‘B Trust.’ It enables better utilization of applicable estate tax exemption and ensures that the intended beneficiaries receive their assets, thus protecting the assets from potential future spouses and creditors.

How does an A-B Trust work?

When one spouse passes away, the A-B Trust splits into two separate trusts – the A Trust, also known as the survivor’s or marital trust, which holds the assets for the surviving spouse’s benefit, and the B Trust, known as the bypass or credit shelter trust, that holds the deceased spouse’s assets. The divisions are typically done to maximize the federal estate tax exemptions for both spouses.

What is the purpose of an A-B Trust?

An A-B Trust serves multiple purposes, including to minimize federal and state estate taxes, protecting assets from potential future spouses and creditors, and ensuring an intended distribution of assets to the chosen beneficiaries, such as children or grandchildren.

Are there any disadvantages of having an A-B Trust?

Some drawbacks to consider include the cost and complexity of establishing and maintaining an A-B Trust, the potentially outdated nature of the trust due to changes in tax laws, and limited access to assets in the B Trust by the surviving spouse.

How is A-B Trust affected by changes in the estate tax laws?

As tax laws evolve, an A-B Trust might not offer as much benefit in terms of the estate tax exemptions as initially planned. Changes in the estate tax exemptions may require a review and update of the A-B Trust strategies to ensure they still serve their intended purpose.

Can an A-B Trust be modified or dissolved once it is set up?

It is possible to modify or dissolve an A-B Trust, but the process can be complicated and might require the consensus of the trust beneficiaries and court approval. It is essential to consult with an estate planning attorney for guidance.

What steps should be taken to establish an A-B Trust?

Couples interested in setting up an A-B Trust should consult with an estate planning attorney or financial advisor to discuss their financial situation, goals, and the legal requirements to implement the trust structure effectively. Proper planning and documentation are necessary to ensure a successful A-B Trust arrangement.

Related Finance Terms

  • Estate planning
  • Marital deduction
  • Irrevocable trust
  • Survivor’s trust
  • Unified credit

Sources for More Information

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