No Estate Tax Worries, so Why an A-B Trust?
Written by Teresa D. Lancaster
Many people are now thinking, My estate is far less than $5,000,000, so I do not need to worry about having a trust. However, that conclusion may be premature as there may be many good reasons to still consider an A-B trust arrangement.
First, what is an A-B trust? This is a type of trust estate planners have been using for years–mainly promoted for married couples for the ability to preserve the estate tax exemption of the first spouse to die. At the basic level, when the first spouse dies, the trust splits into two parts: A and B. The AA@ Trust (also known as the Survivor’s Trust”) is the surviving spouse=s share. The AB@ Trust (also known as the “Family Trust” or the “Decedent’s Trust”) is the pre-deceased spouse=s share, which becomes irrevocable—thereby using the first-to-die’s estate tax exemption. So, if you don=t have a taxable estate why use this type of trust? The reasons are plenty.
First, as we know, tax law changes. After 2012, we do not know what the exemption will be, so a good estate plan can still be a great benefit for estate tax purposes. If you or your spouse passes away during a lower exemption year, then a properly drafted A-B Trust can potentially save your family from a substantial tax liability. For example, if you have $3,000,000 in assets, then in 2011 or 2012, your A-B Trust will not save you any estate tax under the current law. However, in 2013 and later, unless the estate tax is changed again, you could potentially save around $500,000 in estate taxes under an A-B Trust plan.
Perhaps you have read about or heard politicians talking about so-called estate tax exemption Aportability@ and you think that that will save you. However, since the tax law is ever-changing, portability itself may also change or even be eliminated. Moreover, there is very little practical experience with this law and most professionals are fairly uncertain of how effective it will be. If portability is applicable, it is very likely the tax savings will be less than with an A-B Trust arrangement. In short, relying on portability is a potentially risky and untested option.
So you are now thinking, AI most likely will not have to worry about estate tax anyway, so why go through the hassle?@ Well, there are other good reasons to consider having an A-B Trust in place.
In our day-to-day practice, the reason we find many people elect to have an A-B Trust has nothing to do with estate taxes. Often—especially in a case where there are separate children from former marriages—an A-B Trust can bring comfort to each member of a couple by ensuring him or her that a share of their funds will be protected if they die first. This is because the B Trust can be drafted to restrict a surviving spouse from changing the pre-deceased spouse=s beneficiaries. The power to change the B Trust is known as a APower of Appointment@ and it can be very restrictive or less restrictive, based on the couple=s choice. This power can range from having no authority to change the beneficiaries, to limiting the power to make changes only among the pre-deceased spouse=s beneficiaries or charities, and even to change the beneficiaries however the surviving spouse decides.
A second reason to consider an A-B Trust is asset protection. If the B Trust is appropriately drafted, it can provide the surviving spouse with creditor protection, which means that any asset in the B Trust would not be subject to the creditors of the surviving spouse. It can even, in some cases, allow the trustee to use his or her discretion and make the B Trust a Special Needs Trust so that the surviving spouse can qualify for public benefits.
There can be disadvantages to a B Trust. First, you must make sure it is properly drafted. One of the frequent problem areas in a B Trust is the authority left to the surviving spouse under the Power of Appointment. If it is a first marriage with children who are common only to that marriage, you may want this power to be broad. However, if you have separate children from former marriages, you may want this power to be narrow—so the trust has to be drafted to say what you want. Also, there is some additional administrative work involved to set-up the B Trust properly after the death of the first spouse. Lastly, the trustee will have a duty to keep beneficiaries informed of what is happening—which in some families may be an issue.
All in all, you should not rule out the need for an A-B Trust due to the increase in the estate tax exemption. There may be many good reasons to still use this form of estate plan, and it also may help ease the transition for those left after you are gone.