Some married couples prefer an AB living trust (also known as an exemption trust)
to a traditional joint trust because of its flexibility and tax benefits. For many
years, the AB living trust allowed married persons to escape certain estate taxes.
Today, the future of this benefit is uncertain since the estate tax is being gradually
phased out until 2010. Without further legislative action, the estate tax will be
restored in 2011. It is therefore difficult to currently determine what tax benefits,
if any, an AB Living Trust bestows.
However, the AB living trust remains a powerful estate-planning tool. The estate
tax is not scheduled for repeal until 2010, and as of today, will only be repealed
for one year. The wise planner who wants to be prepared can therefore still profit
from an up-to-date AB living trust. The AB living trust affords a measure of security
in that your beneficiaries will receive the assets you earmark for them tax-free.
Moreover, the flexibility afforded by a revocable AB living trust ensures that the
trust instrument can be amended if circumstances change.
How an AB Living Trust Works
Imagine a joint trust with $4,000,000 in assets. If one spouse dies, the majority
of the assets are commonly passed to the surviving spouse. In this example, assume
that the husband dies and all of the trust property is left to the wife. Since there
is no estate tax on amounts transferred from one spouse to another, the wife will
receive the full $4,000,000 tax-free. But when the wife dies and leaves the property
to the children, the trust is only tax exempt up to $2,000,000 (in 2007). The second
$2,000,000 is subject to a very steep estate tax. The children, therefore, will
receive substantially less than $4,000,000 due to federal estate taxes.
On the other hand, with an AB living trust, the surviving spouse never takes legal
possession of the deceased spouse's property. The surviving spouse can use all of
the income generated from the property plus additional amounts for support, but
cannot sell it as he or she pleases. Since each spouse's share is kept separate,
an AB living trust allows both spouses to utilize their estate tax exemptions. This
translates into twice the tax savings and more money to your beneficiaries.
Returning to our hypothetical couple, imagine they set up an AB living trust with
$4,000,000 in assets, rather than a similar joint trust. When the first spouse dies,
the trust splits in two. Trust A contains the husband's share of the trust property,
which now becomes irrevocable. Assume that the husband's share is worth $2,000,000.
This leaves the wife's share, contained in Trust B, worth $2,000,000. The wife cannot
sell the property in Trust A (her husband's share). However, she can use the property
and keep any income it generates. In addition, she can still use, sell, or bestow
the assets in her Trust B.
When the wife dies, the trust property is distributed to the children. Assume the
trust property totaled $4,000,000 at the time of her death, with $2,000,000 worth
of assets in Trust A and $2,000,000 in Trust B. Because the husband's share of the
AB living trust was not immediately transferred to his wife when he died, the husband
remains eligible for his $2,000,000 estate tax exemption. Thus, his $2,000,000 (Trust
A) can be passed on to the children tax-free. Likewise, the wife is eligible for
her $2,000,000 exemption. Her $2,000,000 (Trust B) can also be passed to the children
tax-free. Thus, the children can receive $4,000,000 tax-free and thereby receive
substantially more than they would have with a typical joint trust.
Disadvantages of an AB Living Trust
But AB living trusts are not without their disadvantages. The most important
of these disadvantages is that the surviving spouse cannot sell their spouse's share
of the trust property. The surviving spouse is entitled to income generated by Trust
A and to certain allowances for his or her health and support.
Another disadvantage may be the administrative cost of keeping an AB living trust.
After the first spouse dies, the surviving spouse must keep separate books and records
for Trust A and Trust B to utilize the trust assets properly. Finally, because the
future of the estate tax is uncertain, acquiring the maximum tax benefits under
an AB living trust is a tricky business that will vary from year to year. With an
estate tax repeal set for 2010, even the most careful planner cannot be assured
of any tax benefit.
