An AB trust is an estate planning device that allows married couples to reduce or avoid federal estate taxes. Estate taxes are taxes imposed on estates of a certain size (over $2 million for 2006-08) at the time of an estate holder’s death. By dividing the trust into two parts when one spouse dies, an AB trust reduces the size of the overall taxable estate. With proper planning, a couple who creates an AB trust may avoid probate, escape estate taxes and preserve family assets.
An AB trust is created by establishing a living trust with an AB provision. The trust remains revocable while both spouses are alive. Thus, the couple may withdraw assets or cancel the trust completely before one spouse dies. When the first spouse dies, the trust becomes irrevocable and splits into two parts: the A trust and the B trust. The A trust contains the surviving spouse’s half of the estate. The surviving spouse controls all the property in the A trust and may receive distributions of income and principle as needed. The B trust contains the deceased spouse’s half of the estate. The B trust belongs to the beneficiaries named in the trust—typically the couple’s children. The surviving spouse has the right, however, to use the property contained in the B trust during life and to receive any income it generates. In certain situations, the surviving spouse may access the principle of the B trust. When the surviving spouse dies, the property in the B trust passes to the beneficiaries designated in the original trust document. The assets contained in the A trust are distributed to beneficiaries named by the surviving spouse.
Advantages of an AB Trust
The property in the B trust is never considered part of the surviving spouse’s estate. Thus, only the property contained in the A trust is subject to estate taxes at the time of the surviving spouse’s death. If the A trust contains less than the estate tax exemption, then no estate taxes will be imposed. Even if the trust contains more than the estate tax exemption, the total estate is significantly reduced. For example, if a surviving spouse dies in 2007 with no AB trust in place, and an estate worth $3 million, $1 million of the estate will be subject to estate taxes after the $2 million tax exemption is taken. With an AB trust, however, the surviving spouse’s estate would be worth only $1.5 million. Because this is less than the $2 million estate tax exemption, no portion of the estate is subject to estate taxes. Additionally, property contained in a living trust is not subject to the probate system, which often results in significant expense and delays in asset distribution.
Disadvantages of an AB Trust
There are several disadvantages to an AB trust. Accounting, legal and administration fees must be paid to maintain the trust. Additionally, after the death of the first spouse, the A and B trusts requires separate tax returns. The AB trust also limits the surviving spouse’s rights to the trust property. A surviving spouse may feel entitled to all the property in the B trust, and may wish to spend the trust principle. This may conflict with the beneficiaries of the trust who wish to conserve the trust assets. Because an AB trust becomes irrevocable once the first spouse dies, an AB trust should be created only after consultation with an estate planning professional.