Legal Definitions - AB Trust

An AB Trust refers to a specific estate planning strategy for married couples that involves creating two separate trusts, commonly designated as Trust A and Trust B, upon the death of the first spouse.

Historically, the primary purpose of an AB Trust was to help married couples legally maximize their individual federal estate tax exemptions, thereby reducing the overall estate tax burden on their heirs when both spouses had passed away. Here's how it generally works:

• When the first spouse dies, their assets are divided and allocated to two distinct trusts:
  • Trust B (also known as a Bypass Trust or Credit Shelter Trust): This trust receives assets from the deceased spouse, typically up to the current federal estate tax exemption amount. Trust B is designed to be irrevocable, meaning its terms generally cannot be changed after its creation. While the surviving spouse may receive income from Trust B to support their lifestyle, they do not have control over the principal (the main body of assets). The assets in Trust B are ultimately designated for other beneficiaries, usually the couple's children, and are structured to "bypass" the surviving spouse's taxable estate. This ensures that the deceased spouse's estate tax exemption is fully utilized and those assets are not taxed again upon the surviving spouse's death.
  • Trust A: This trust holds the remaining assets, including the surviving spouse's own property and any of the deceased spouse's assets that exceed the amount placed into Trust B. The surviving spouse typically has full control over Trust A, meaning they can use, manage, or modify these assets as they wish during their lifetime.
• Upon the death of the second spouse, both Trust A and Trust B distribute their respective assets to their named beneficiaries.

While AB Trusts were a cornerstone of estate planning when federal estate tax exemptions were lower, their relevance for federal tax planning has diminished for many couples due to significantly higher federal estate tax exemptions and the introduction of "portability." Portability allows a surviving spouse to use any unused portion of their deceased spouse's federal estate tax exemption. However, AB Trusts can still be beneficial in specific situations, such as:

• Minimizing State Estate Taxes: Some states have their own estate or inheritance taxes, and these state laws may not offer portability for a deceased spouse's exemption. An AB Trust can be a valuable tool to ensure both spouses' state-level exemptions are fully utilized, potentially saving heirs significant state tax liabilities.
• Protecting Assets for Blended Families: In second marriages or blended families, an AB Trust can ensure that assets from the first spouse are ultimately passed to their children from a previous marriage, while still providing for the financial needs of the surviving spouse during their lifetime. This prevents the surviving spouse from potentially redirecting those assets to their own heirs or a new spouse.
• Managing Extremely Large Estates: For couples with exceptionally large estates that exceed the combined federal estate tax exemption even with portability, an AB Trust can still be an effective strategy to further reduce federal estate taxes by locking in the first spouse's exemption and preventing those assets from being included in the surviving spouse's estate.

Due to their complexity and associated legal and administrative costs, it is crucial for individuals considering an AB Trust to consult with an estate planning expert to determine if it is the most appropriate strategy for their specific financial situation and goals.