An AB trust is a living trust for married couples that divides their wealth into two trusts, A and B, to reduce or eliminate inheritance taxes for their descendants. The deceased spouse’s estate is placed in an irrevocable trust accessible to the surviving spouse. However, there are flexibility issues to consider, and the benefits are subject to changes in estate tax laws.
The AB trust is the wife’s half of the AB trust, a type of living trust designed for married couples. Also known as a spousal bypass trust, an AB trust is designed to help the beneficiaries of wealthy married couples escape property taxes. While in a normal situation one spouse’s estate is transferred to the other upon the death of the first spouse, an AB trust provides for the deceased spouse’s estate to be placed in an irrevocable trust. This trust is accessible to the surviving spouse and, if managed properly, can significantly reduce or even eliminate inheritance taxes for the couple’s descendants when both are deceased.
Estate tax laws change all the time and so the benefits of an AB trust are somewhat at the mercy of lawmakers. Assuming the standard situation of property taxes and one-time wealth tax breaks to pass upon someone’s death exists, this trust can be very beneficial. In short, it divides a couple’s wealth into trust A for the husband and trust B for the wife.
For example, a married couple has $3,000,000 of US dollars (USD) in their assets. If there is no inheritance plan in place and the husband dies, half of his estate goes to the wife. With a spousal bypass trust in place, the husband’s wealth would go into an A trust. The wife would have access to this trust for necessary expenses. Upon her death, her wealth would go to trust B, and both trusts would pass on to any children, descendants, or whoever the couple chose to be heirs to their wealth.
If, in the above example, a federal estate tax exemption of $2,000,000 USD were in effect, both trust A and trust B would pass to the children below the limit, allowing them to inherit the tax-free property. This is much more beneficial to the heirs than if the inheritance had been passed down entirely by the surviving spouse. In such a scenario, a third of the couple’s estate would be subject to steep estate taxes.
The tax benefits of an AB trust are clear, but there are some flexibility issues that could make it disadvantageous in some cases. For example, the surviving spouse has access to the deceased’s trust but cannot sell the assets therein. If the inheritance includes assets, the surviving spouse may also be prevented from moving to a new home. Any excessive use of trust assets by the surviving spouse could lead to scrutiny by tax officials.
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