Introduction to A/B Marital Trusts
In estate planning, the strategic use of A/B Marital Trusts has been a cornerstone for couples aiming to optimize their estate tax exemptions and ensure the preservation and transfer of wealth to their heirs with tax efficiency. Historically, these trusts have been a popular tool when the estate tax exemption amounts were much lower and many more clients were subject to estate taxes. However, with the current high estate tax exemption amounts, the frequency of employing A/B trust planning has seen a decline. This trend might see a reversal as the exemption amount is set to sunset to previous levels in 2025, making A/B trusts an attractive option once again for those looking to minimize estate taxes. A-B Trust: Definition, How It Works, Tax Benefits
Understanding A/B Marital Trusts
A/B Marital Trusts, also known as bypass or credit shelter trusts, are designed to benefit the surviving spouse and other beneficiaries by creating two separate trusts upon the death of the first spouse. These trusts are structured to take full advantage of the estate tax exemption for both spouses and the unlimited marital deduction, thereby reducing or eliminating estate tax liability upon the death of the surviving spouse.
Hypothetical Example of A/B Trust Planning with Infographic
In our hypothetical example set in 2024, consider a couple with a combined estate worth $21 million, comprised of $20 million in community property and $1 million in separate property owned by one spouse. Upon the death of the first spouse, the estate tax exemption is strategically utilized to funnel assets into two distinct trusts: the Survivor’s Trust and the Bypass Trust. The Survivor’s Trust receives the surviving spouse’s half of the community property and all their separate property, while the Bypass Trust is allocated the deceased spouse’s half of the community property and their separate property up to the deceased spouse’s applicable exclusion amount.
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The Benefits of A/B Trusts Beyond Tax Savings
This planning ensures that no estate tax is due at the first spouse’s death due to the use of the bypass trust and the unlimited marital deduction. Assets within the Bypass Trust appreciate to $12 million by the second spouse’s death, growing outside of the surviving spouse’s estate and thus not subject to estate taxes for beneficiaries. Conversely, the Survivor’s Trust could face estate taxes if its value exceeds the estate tax exemption at the time of the second spouse’s death.
The fluctuating nature of tax laws underscores the importance of adaptable estate planning strategies that can protect assets and minimize tax liabilities.
Portability vs. A/B Trusts for Estates Below the Exemption Threshold
For individuals and couples whose estates do not exceed the estate tax exemption, portability—the ability to transfer the unused estate tax exemption of the deceased spouse to the surviving spouse—offers a simpler and tax-efficient alternative. This approach avoids the potential capital gains tax implications associated with the Bypass Trust’s lack of a step-up in basis for assets upon the second spouse’s death.
Special Considerations: Blended Families and A/B Trusts
However, there are scenarios where an A/B trust structure might still be preferable despite the estate being below the tax threshold. Particularly in cases of blended families, where there may be a desire to ensure that assets are distributed according to specific wishes, such as to children from previous marriages, while still providing for the surviving spouse. The A/B trust structure can offer more control over the distribution of assets, protecting the interests of both the surviving spouse and other beneficiaries in a way that portability alone may not.
Conclusion: Aligning Estate Planning with Personal Wishes
This tailored approach underscores the importance of considering family dynamics, alongside tax implications, in estate planning. It highlights that while tax efficiency is a critical component, the overarching goal of estate planning is to align the distribution of one’s estate with their personal wishes and family circumstances, ensuring that assets are protected and passed on in the most beneficial manner for all involved.
Related:
Portability and the Unlimited Marital Deduction – Explained Step by Step
