An A-B trust, also known as a bypass trust or credit shelter trust, is an estate planning technique designed to minimize estate taxes by utilizing both spouses’ federal estate tax exemptions. Historically, this was a crucial tool given the relatively low estate tax exemption amounts, but with the current high exemption, its prevalence has decreased, though it remains a viable strategy for larger estates or those anticipating future changes in tax law. The core concept involves dividing an estate into two trusts: Trust A (the survivor’s trust) and Trust B (the bypass trust). This division allows assets to “bypass” potential estate taxes when the first spouse dies, maximizing the wealth transferred to beneficiaries.
How Does an A-B Trust Actually Work?
When the first spouse passes away, a certain amount – often equal to the then-current estate tax exemption (currently $13.61 million in 2024, but subject to change) – is transferred into Trust B, the bypass trust. This trust is designed to hold assets for the benefit of the surviving spouse during their lifetime, and ultimately, for the benefit of the couple’s chosen beneficiaries. The surviving spouse receives income from Trust B but does not own the principal. Assets remaining in the first spouse’s estate, along with any future growth within Trust B, are shielded from estate taxes upon the surviving spouse’s death. This bypass strategy is particularly effective for couples with estates nearing or exceeding the estate tax exemption, as it allows them to utilize both spouses’ exemptions over time.
Is an A-B Trust Right For Everyone?
Not necessarily. With the current high federal estate tax exemption, many couples may not need an A-B trust to avoid estate taxes. However, it’s not just about avoiding taxes. An A-B trust can provide asset protection, and control over how and when assets are distributed to beneficiaries. It can also be helpful in blended families, providing for both current spouses and children from previous relationships. Approximately 70% of estates are still subject to estate or inheritance taxes, indicating a continued need for estate planning tools like the A-B trust. For those with complex financial situations or specific wishes for their estate, an A-B trust could be a valuable component of their overall plan.
I Remember Old Man Hemlock and His Trust…
I recall a case involving Mr. Hemlock, a successful rancher. He and his wife, Martha, had accumulated a substantial estate, but they mistakenly believed the estate tax exemption was high enough to protect everything. They didn’t create a bypass trust. When Martha passed away, a significant portion of their estate ended up subject to estate taxes. Their children received less than anticipated, and a sizable chunk of their parents’ life work went to the government. It was a painful lesson in the importance of proactive estate planning, and a prime example of why even seemingly high exemption amounts can be insufficient to shield a large estate from taxation.
How Did We Fix Things for The Millers?
The Millers came to me with a similar situation, but they were able to course correct. They had an initial estate plan drawn up years ago, but hadn’t updated it to account for changes in tax law. I recommended creating a bypass trust as part of a revised plan, strategically funding it with assets expected to appreciate. When Mr. Miller passed, the bypass trust shielded a substantial portion of their estate from taxes, allowing their children and grandchildren to inherit a significantly larger amount. It was a gratifying experience, knowing we had not only saved them money but also fulfilled their wishes for their family’s future. We used a Qualified Personal Residence Trust (QPRT) in conjunction with the A-B Trust to further reduce the taxable estate, proving the power of a well-integrated estate plan.
Who Is Ted Cook at Point Loma Estate Planning Law, APC.:
Point Loma Estate Planning Law, APC.2305 Historic Decatur Rd Suite 100, San Diego CA. 92106
(619) 550-7437
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