Wealth Preservation - How the AB Trust works for Married Couples
The AB Trust in 2011 – How it works for Married Couples *
The AB Trust is a well established and proven estate planning technique for married couples that is used to preserve wealth and minimize or avoid estate taxes by combining the estate tax exemptions of both spouses. It is an effective technique but is not necessarily right for every married couple or every situation.
This briefing paper will explain how the AB Trust works using the estate tax exemption established by Tax Relief Act of 2010 enacted December 17, 2010. Note this law is scheduled to sunset in 2012 and if it does, the pre-Bush tax cut amounts and rates ($1,000,000 estate, gift and generation-skipping transfer tax exemption and a 55% tax rate) would return.
In order to establish an AB Trust, each spouse establishes his or her own Will with a Testamentary Trust or Revocable Living Trust with the appropriate AB Trust language. (Revocable Living Trusts with pour over wills are highly rcommended by the author as an advantageous method of avoiding the time and cost of probate.)
The couple titles their assets, based on relevant Estate Tax exemptions including a state estate tax if applicable in their state, in appropriate amounts in his or her individual Revocable Living Trust. Spouses who are United States Citizens may transfer assets to each other because they may make unlimited gifts to each other without paying a Federal gift tax. If couples do not place their assets in separate trusts but hold them jointly, the use of the AB Trust is ineffective because the jointly held assets will pass outright to the surviving spouse instead of through the deceased spouse's Will and Testamentary Trust or Revocable Living Trust.
If the first spouse dies in 2011 or 2012, then the first $5,000,000 of his or her assets will be funded into the B Trust. This effectively uses the first spouse's $5,000,000 federal exemption from estate taxes that is available for deaths occurring during these years. The B Trust can be relatively flexible and used for the benefit of the surviving spouse and descendants or other beneficiaries.
If the deceased spouse's assets exceed $5,000,000, then the excess is funded into the A Trust. This will defer the payment of estate taxes on the assets above the deceased spouse's $5,000,000 exemption until after the surviving spouse's death. Because of this estate tax deferment, the A Trust is less flexible and can only be used for the benefit of the surviving spouse. In addition, the surviving spouse is required to receive all of the income from the A Trust.
When the surviving spouse later dies, the surviving spouse will still have his or her own estate tax exemption. If the exemption is $5,000,000 when the surviving spouse dies, then the first $5,000,000 of the surviving spouse's separate assets will pass estate tax free to the final beneficiaries. Anything over $5,000,000 will be taxed.
The assets remaining in the B Trust pass estate tax free to the final beneficiaries. This is because the B Trust used up the $5,000,000 exemption of the first spouse to die, so anything left in the B Trust will pass estate tax free. This can provide a significant windfall to the final beneficiaries if the surviving spouse doesn't need to use the assets from the B Trust and they continue to grow in value during the surviving spouse's remaining lifetime.
The assets remaining in the A Trust will be taxed as part of the surviving spouse's estate. As mentioned above, the estate tax on the A Trust is effectively deferred until after the surviving spouse dies.
The balance of the A Trust that remains after the estate tax bill is paid passes to the final beneficiaries.
As illustrated above, effective use of the AB Trust system under the provisions of the Tax Relief Act of 2010 allows married couples to pass on up to $10,000,000 to their final beneficiaries, free from any federal estate taxes.
* This briefing paper is for informational purposes only and is not legal advice. Receipt of this briefing paper does not establish an attorney client relationship between the recipient and Paul R Hales.