Do I Still Need an AB Trust?

Due to changes in federal and state laws over the past decade, many of the AB trusts created prior to 2011 may no longer be the most desirable method of estate planning for a married couple. This blog explains why AB trusts are a thing of the past for many families who prefer a simpler revocable trust design that provides maximum flexibility for the surviving spouse.  

How AB Trusts Work

An AB Trust, sometimes referred to as a bypass trust, was once the standard method preferred by estate planners to minimize, or avoid, federal and state estate tax. With an AB trust, after the first spouse to die, the A trust is funded with the surviving spouse’s assets and remains revocable. The B trust or “bypass trust” becomes irrevocable and is funded with the deceased spouse’s assets up to an amount equal to the estate tax exclusion allowable by law. Any assets beyond the exclusion amount transfer to the surviving spouse outright or to a trust for the surviving spouse’s benefit in order to use the unlimited marital deduction. All of the separate and community property assets owned by the first spouse to die receive a cost basis adjustment at his or her death. The assets transferred to the surviving spouse will receive another cost basis adjustment when the surviving spouse dies. The assets held in the B trust will not receive the additional cost basis adjustment when the surviving spouse dies.

What Has Changed

Beginning in 2011, the federal estate tax exclusion was made transferrable between married couples. This concept is referred to as “portability.” Portability means that after the first spouse dies, the unused portion of his or her federal estate tax exclusion can be added to the surviving spouse’s estate tax exclusion as long as an estate tax form is filed within the required time frame after the first spouse dies. In 2012, the estate tax exemption amount was increased to $5 million plus an inflation adjustment, which in 2012 was $5,120,000. With portability, a combined total of more than $10 million dollars excluded from estate taxes meant that the AB trust would make sense for fewer couples. Under the recent tax law change, the basic exclusion was increased to $10,0000, before taking into account the necessary inflation adjustment. (This increase is set to expire on December 31, 2025, and return to the previous amount.) In 2018, the estate tax exclusion amount is $11.2 million dollars for each spouse for a grand total of $22.4 million dollars. This enormous increase, paired with portability, means that only a very small percentage of couples will need an AB trust in order to avoid paying federal estate tax.

Should I Keep My AB Trust?

While the most common purpose for an AB trust has been to avoid estate tax, there are other reasons for having an AB trust that still make sense. If you happen to be one of the lucky few who are close to the $22.4 million cap, you may be able to avoid future estate tax if the estate grows after the death of the first spouse since the appreciation of assets in the B trust is not subject to additional estate tax. Having a B trust may offer protection from future creditors. Having a B trust also ensures that the deceased spouse can retain control over his or her assets and prevent his or her designated beneficiaries from being changed after death. This may be desirable for some couples in the event that the surviving spouse gets remarried. This feature can be especially relevant to blended families with spouses that have children from prior relationships.

If none of these benefits pertain to you, you may want to consider restructuring your AB trust. An AB trust can be more expensive when it comes to legal and accounting costs. There is typically more administrative work involved that requires more time and cost. Another drawback is the inability to gain a second step up in basis after the surviving spouse die, which may lead to higher potential capital gains tax.

This blog only provides a general overview based on current law. Everyone’s situation is different. There is no “one size fits all” estate plan. Before making any decision, you should consult with an Estate Planning Attorney to help you weigh the pros and cons of using an AB trust design and make the best decision based on your individual needs. [Disclaimer]

Our estate planning team at Naimish & Lewis can advise you on estate planning, trusts and estates administration, and probate related matters such as probate administration, conservatorship and guardianship. To schedule an initial consultation with an attorney at our firm for a new estate plan or to review an existing estate plan, please contact us