An AB trust is a living trust set up by spouses to leave their estate to beneficiaries and reduce estate tax. The estate is divided into separate trusts, an A trust and a B trust, with limited control over the assets. The arrangement benefits the wealthy and has some disadvantages.
An AB trust is a type of living trust set up by spouses to leave the wealth of an estate to their children or other beneficiaries to take advantage of favorable estate tax laws. Instead of one spouse simply leaving the estate to the other upon their death, an AB trust, also known as a spousal bypass trust, requires the couple to divide the estate into separate trusts which are transferred to their chosen beneficiaries when either spouse dies.
The main benefit of this type of trust is that it allows each spouse to use the estate tax exemptions to reduce, or even eliminate, the tax burden on the beneficiaries of the inheritance. While the surviving spouse may benefit from income generated by the deceased spouse’s trust, the downside of the arrangement is that you have limited ability to control or use the trust assets.
If a couple forms a joint trust, the entire estate goes immediately to one spouse upon the death of the other. When the surviving spouse dies, the estate, if it exceeds the federal estate tax exemption level, is subject to significant estate tax when it is passed on to children or other beneficiaries. This primarily affects families in the higher income brackets, meaning that the wealthy will benefit the most from placing the estate in an AB trust.
In an AB trust, the couple divides their assets and wealth equally and distributes them between two trusts, an A trust and a B trust. For example, a couple with assets of US$6 million would put US$3 million into each trust fund. This division could bring each trust under the federal property tax exemption level. Using this example, if the husband dies first, her trust A would pass to her children or beneficiaries, and if the amount inside were within the exemption limit it would not be subject to inheritance tax. The wife may still live on the estate, be entitled to benefits from fund A as well as any income generated by her assets, and still have access to funds from her fund B.
When the wife dies, she passes her B trust on to her beneficiaries, who can be the same person or people tagged for the A trust. Also using this exemption, funds in trust B can also be transferred with minimal property tax or Nothing.
There are some disadvantages to an AB trust. The surviving spouse has only limited access to the funds within the deceased spouse’s trust, and excessive use of those funds could cause Internal Revenue Service scrutiny. Also, the surviving spouse cannot sell any of the assets bequeathed by the deceased spouse, meaning that any sort of move to a different location would be very difficult.
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