What is an AB Trust?

An AB trust serves multiple purposes. An AB Trust is very similar to a living trust. It is a trust between a married couple used to avoid probate, to ensure that your assets and belongings are distributed at your death, but most importantly, an AB Trust is used to avoid large estate tax penalties.

Who benefits from an AB Trust?

An AB Trust is set up specifically for couples with large estates. Typically, if the value of the couple’s estate exceeds that of the federal estate tax exemption, an AB Trust will be valuable to the couple. In order to understand the AB Trust fully, it is necessary to understand the estate tax exemption laws. When you die, your assets, property, and possessions are assessed for the purposes of estate taxes. The estate tax rate is rather high, a whopping 45%. However, not all of your estate is subject to tax. The government has built in an estate tax exemption, which allows for a certain portion of a deceased persons estate to pass to their heirs tax free. In 2009, the estate tax exemption is $3.5 million. This means that unless your estate is worth more than $3.5 million, it will pass to your heirs tax free. If your estate is worth $4 million at the time of your death, $3.5 million will be tax free, but $500,000 will be assessed at a 45% tax rate. That means that $225,000 will be sent to the federal government. That amounts to almost a quarter of a million dollars that your heirs will not receive. These are the estate tax basics, it gets more complicated. Due to some clumsy tax law (which is currently being debated and amended in congress) in 2009 the estate tax exemption is $3.5 million. In 2010, however, the estate tax exemption is 100%, meaning that if you die in 2010, the entirety of your estate passes to your heirs, untaxed. If, however, you were to die in 2011, only $1 million of your estate would be tax free. These complicated laws are likely to change, but it is important to understand them so that you can understand the worth of the AB Trust. In fact, one of the beauties of the AB Disclaimer Trust mentioned below is that it allows for the surviving spouse to make decisions based on the current tax laws.

How does an AB Trust work?

An AB Trust, while seemingly quite complicated, makes very practical sense when it is understood with knowledge of estate tax exemptions. An AB Trust is created between two married couples. While the AB Trust falls under the category of one single trust, it is actually two trusts contained under the same legal document. Essentially, both spouses set up a trust so that upon their death, their assets go to Trust A. Since it is necessary for a trust to have a trustee, it is common practice for each spouse to name the other as the trustee of their trust. Then, both spouses name each other as the “life beneficiary” of their respective trusts. This means that for the life of the surviving spouse, they are allowed to use the assets of the trust to provide for themselves as they see fit. This addresses the fundamental concern of many couples, that the surviving spouse be financially stable. The life beneficiary designation allows the surviving spouse to gain many benefits of the property in the trust, without ever having legal ownership of the assets in it. Finally, each spouse names the “final beneficiaries” of their trust. The final beneficiaries are who the property will pass on to upon the death of the second spouse. Once the first spouse dies, the surviving spouse’s property will enter into the B Trust. This is the property which will comprise his or her estate and pass on to the surviving spouse’s heirs on his or her death. This type of trust has two goals: 1) it provides financial stability to the surviving spouse while still allowing the property to be passed on as both spouses designate, and 2) since the surviving spouse is never given legal ownership of the property in the deceased spouse’s trust, the property is not added to the surviving spouse’s estate. Ideally, a couple will split up their assets so that on the death of either spouse they will remain under the estate tax exemption and therefore not have to pay estate taxes.

What is an AB Disclaimer Trust?

An AB Disclaimer Trust is very similar to an AB Trust. The one difference is that upon the first spouse’s death, the surviving spouse decides how much, if any, of the deceased spouse’s property will enter the A Trust. This fluidity has positives and negatives to it. Since the estate tax law is in constant limbo at the moment, an AB Disclaimer Trust allows for the surviving spouse to determine exactly how much of the deceased spouse’s estate will enter the trust for the purposes of estate taxes. This will allow the surviving spouse and the beneficiaries of each trust to maximize their estate tax exemptions. There is a possibility that the surviving spouse will make a decision which is not based on the most sound tax thinking. Since the surviving spouse has complete control of the deceased spouse’s assets, it would be foreseeable for the surviving spouse to decide to inherit all of the property for reasons other than sound estate planning.

Drawbacks of an AB Trust

An AB Trust provides many benefits, but also has some drawbacks that must be considered. The AB Trust sets limitations on the way that the surviving spouse can utilize the property in Trust A to provide for themselves. Also, there are considerable administrative expenses that come with dividing the assets on the death of the first spouse. It is often necessary to seek the help of an attorney or accountant to assist with this division. A yearly tax return is required for Trust A once it becomes operational, adding some hassle to the process. An AB Trust also requires strict record keeping to ensure that Trust A and Trust B remain separate after the death of the first spouse.

As with any estate planning device, there are many intricacies which would be impossible for this article to cover completely. In light of this, and the complicated nature of AB Trusts and AB Disclaimer Trusts, it is in your best interests to see an experienced estate planning attorney to determine which combination of estate planning devices are appropriate for you. Most likely, an attorney can suggest multiple different avenues of estate planning to ensure that your beneficiaries receive your assets as quickly, hassle free, and tax free as possible. Only an attorney can help you to maximize your estate planning benefits.