How can I benefit from an A/B Trust?
Investing in an A/B Trust may be financially beneficial to couples and their loved ones in many ways. Some of the reasons to consider investing in an A/B Trust are:
- An A/B Trust can help you double the life time exemption from the federal estate tax.
- Investing in an A/B Trust ensures that your surviving spouse is well taken care of financially after your death.
- If you are a surviving spouse, with an A/B Trust you have the access to the income from the trust for life and can use the principal, if necessary, for your health, education, support and maintenance.
- An A/B Trust assures that your children, if chosen as the beneficiaries, will maximally benefit from your assets after your and your spouse’s death.
- An A/B Trust gives you the ability to include a remarriage restriction.
- *A remarriage restriction limits the ultimate beneficiaries of the deceased spouse’s estate to the children of the current marriage. If a surviving spouse remarried, he or she would not be allowed to change the beneficiaries selected by the deceased spouse.
- An A/B Trust may avoid or reduce federal estate taxes in situations when a couple’s actual estate at the time of the second spouse’s death is much higher than expected.
How does it work?
Under the current law, spouses can leave each other an unlimited amount when they die, with no estate tax, because of an IRS tax exemption provision called the unlimited marital deduction. The marital deduction allows the first deceased spouse to leave his or her entire half of the estate to the surviving spouse tax-free. However, when the surviving spouse dies and passes the combined estate to his or her heirs, the estate will only benefit from the surviving spouse’s tax exemption. Therefore, the exemption of the first spouse gets wasted.
An A/B Trust is used as a tool to preserve the exemption of the first spouse to die. When the first spouse dies, any amount up to $2 million, which is the current applicable exclusion amount, is placed into the A/B trust. This trust is not taxed at that time or at the later death of the surviving spouse.
An A/B Trust begins as a single revocable trust, but when one of the spouses dies, the trust divides into subtrusts. Trust A or the Survivor’s Trust remains revocable and contains the survivor’s property interests, and the surviving spouse has total control. This trust usually receives all assets that exceed the applicable exclusion.
* The applicable exclusion amount exempts a certain amount of gifts made during your life from federal gift tax and exempts a certain amount of your estate from federal estate tax. The current estate tax applicable exclusion amount is $2 million.
The applicable exclusion amount will increase to $3.5 million in 2009. The federal estate tax will be repealed on January 1, 2010 until December 31, 2010. Beginning 2011, the federal estate tax will be reinstated with a federal estate tax exemption amount of $1 million and a maximum estate tax rate of 55%. Currently, bills are pending in Congress that, if passed, would permanently repeal or otherwise lessen the impact of the federal estate tax.
Even if you believe that that you may not be affected by the federal estate tax, you still need to determine whether you may be subject to state estate taxes and whether you will have a taxable estate in the future as your assets appreciate in value. You should regularly review your estate plan with an experienced estate planning attorney to make adjustments to reflect changes in the tax laws as well as changes in your individual circumstances.
Trust B or the Credit-Shelter Trust is irrevocable. The Credit-Shelter Trust contains the deceased spouse’s assets that can pass tax free, equal to the unused applicable exclusion. This trust is designed as a bypass trust so that it can pass to the next generation of beneficiaries without triggering a transfer tax. During the life of the surviving spouse, he or she can use the funds from Trust B for the purposes of health, support and maintenance.
The survivor’s Estate Tax Exemption Amount will be applied to the assets held in the survivor’s trust so that a portion (or all) of the survivor’s trust will also pass to the next generation free of estate taxes.