Estate Planning Lawyer Definitions: A-B Trust

Talk to any estate planning attorney long enough and you are sure to hear them mention the A-B trust. Today, you get to find out what that is.

The A-B trust actually is two trusts instead of one, though they work together to achieve their desired result.

A-B trusts can only be created by married couples, as one trust is for one spouse and the second is for the other.

This trust is only created for one reason – to avoid estate planning taxes.

But before we get to that, let’s talk about what A-B trusts are.

The “A” Trust

The “A” trust is simply the designation given to the first trust. This trust is established for the benefit of the surviving spouse and is usually funded at the time the first spouse passes away.

The surviving spouse is typically the trustee and the beneficiary of the “A” trust, which is a revocable trust. The assets within this trust will be added to the surviving spouse’s estate when they pass away.

The “B” Trust

The “B” trust is simply the designation given to the second trust. It is also referred to as the “bypass trust” (this may also be why it gets the “B” designation).

When spouse one dies their half of their property, up to the estate tax exemption amount ($2 million if you are talking about Washington State, $5.4 million if you are talking about federal taxes).

This property is held in an irrevocable trust. That means that the terms of the trust cannot be changed.

The trust is managed by a trustee that is not the surviving spouse. The surviving spouse is the beneficiary and are entitle to the income from the trust outright as well as to the principle of the trust for health, education, maintenance, and support.

When the surviving spouse passes away the assets within this trust, including any additional value the trust has created, will pass on to the successor beneficiaries designated by the first spouse to pass (usually children, etc.).

The assets within the “B” trust are not part of the surviving spouse’s taxable estate when they pass away.

Why Create an A-B Trust?

There are actually two reasons why people do this.

A-B Trust Reason #1: Avoiding Estate Taxes

The first reason is to avoid paying as much estate tax as possible. Without using this trust structure, the surviving spouse would be charged for the entire value of the estate, and would have to pay taxes on that.

Here’s an example:

Husband (H) and wife (W) have assets of about $4 million, and they live in Washington state.

Scenario 1: No A-B Trust

In scenario 1, H passes away without having created an A-B trust. At that time W doesn’t have to pay any estate taxes on H’s assets because spouses are allowed to pass as much wealth on to their spouse as they want tax free (called the spousal deduction).

When W dies, however, her taxable estate is now $4 million. In Washington State everything over $2 million is charged with an estate tax. W’s family ends up paying upwards of $400,000 (20%) in estate taxes.

Scenario 2: A-B Trust

In scenario 2, H and W set up an A-B trust. When H passes away, $2 million in assets, the amount in Washington State one can distribute without having to pay any estate taxes, goes into the “B” trust.

Although W does not technically have complete control over the funds in the B trust she is entitled to any income earned from the trust and the principal of the trust for health, education, support, and maintenance (very broad terms).

Her assets are put into the A trust, which she has complete control over.

When W dies, the assets in the B trust are distributed according to the terms of the trust as are the assets of the A trust.

But, because the B trust exists, W’s taxable estate is only $2 million, meaning no estate taxes are due at all.

The A-B trust just saved you around $400,000.

A-B Trust Reason #2: Control

Another reason to create an A-B trust is that it gives the spouse that dies first a little more control over their assets.

If no trust is created then the surviving spouse has full control over the allocation of assets in the future. They could remarry and give everything to their new spouse, for example.

If an A-B trust exists, then the first spouse to pass away can dictate where the remaining assets go after the surviving spouse passes away.

There is one caveat here, though: you must remember that the surviving spouse has access to everything in the B trust for health, education, maintenance, and support, which means there is the chance they could spend it all in their lifetime.

At the end of the day, if you are married and your net worth is approaching $2 million, you need to begin considering creating an A/B trust.

Cheers,

Christopher Small

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Christopher Small is a Kirkland estate planning attorney who helps people get rich and live forever. He is also the owner of CMS Law Firm LLC.