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What Are AB Living Trusts, How Do They Work?

Troy Werner and his family

Written by Troy Werner

Troy Werner has been an indispensable asset to The Werner Law Firm since joining in 2009, providing exceptional legal service to its clients.

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POSTED ON: November 30, 2017

Estate planning is the art of ensuring that your wealth remains as untouched as possible, without cheating the government out of any necessary taxes. A legally sound and competent estate plan can be the make-or-break difference between paying millions of dollars in taxes, or leaving your inheritors with an estate that is mostly intact. Among some of […]

Estate planning is the art of ensuring that your wealth remains as untouched as possible, without cheating the government out of any necessary taxes. A legally sound and competent estate plan can be the make-or-break difference between paying millions of dollars in taxes, or leaving your inheritors with an estate that is mostly intact.

Among some of the tools estate planners use is the AB trust. But its usage is quite situational – understanding how it works gives you a better idea of whether it might be applicable to you and your estate planning goals.

AB Living Trusts Explained

When you die and leave behind a considerable amount of wealth for your children, what you leave behind is heavily taxed (unless you’re within the tax exemption limit). If you die while your spouse is still alive, then your total wealth will flow over to them without any taxation, because of the unlimited marital deduction – but when they pass on, only their estate tax exemption counts, leading to a significant loss of value for your estate.

To prevent this, couples can set up an AB trust for their combined estate. When the first spouse dies, their wealth passes on into two separate trusts – trust B is an irrevocable trust known as the bypass trust, equal to the total tax exemption of the year that they died, and trust A is everything else, known as the survivor’s trust. This is under complete control of the remaining spouse.

The surviving spouse’s wealth will be in trust A – and they’ll have limited control over trust B. When they die, only trust A is taxable – trust B remains untouched, and both trusts are under complete control of their beneficiaries: your kids, typically.

Why AB Trusts Are Unpopular

An AB trust used to, quite simply, be designed for married couples who wanted to make the most of their combined fortune, and leave their wealth to their children in a way that didn’t cut into their estate through taxes and didn’t completely cut one’s access out of the other’s wealth after one passes. However, while they indeed can still be used to do that, there may potentially be better ways for couples to pass on their wealth.

For example, tax exemptions can be transferred (or in a better word, combined). The estate planning can be set up to combine the tax exemption of both spouses, so that if their wealth is below their combined exemption, they don’t have to worry about the massive costs of an estate tax on their estate, and they can pass on what they own to their children in peace. Beyond a certain amount of money, though, things stop being that simple. If your combined tax exemption does not exceed your combined wealth, then the AB trust can be an effective way to limit your losses.

Ultimately, this piece of estate planning tech is built for wealthy couples. If you’re the average couple, then you don’t stand to gain much of anything by opting for an AB trust, if you opt to build a trust at all. This sheds further light on just how complicated estate planning can get without a proper consultation.

If you’re married, and your combined wealth far exceeds your states limitations for estate tax exemption, then an AB living trust can help you see to it that if one of your dies, the other retains as much of the wealth as possible.

Then, the actual creation of the AB living trust becomes a factor. While setting up an AB living trust is not an act of witchcraft, it can reduce the control one spouse has over the assets of their significant other. An AB living trust is not the ideal way to give your spouse all of what you own – rather, you get to create an irrevocable trust for them that gives them access to most of what you own, save for a principle that can’t be touched until they have passed as well, at which point the trust is under the control of the primary beneficiaries.

This has its benefits – for example, it ensures that one spouse’s wealth carries over at least in part to the children and grandchildren even if the other spouse remarries and has more kids. However, it does mean that you end up overall limiting how much you can give your spouse upon your death.

But if your combined wealth does not put you over the current tax exemption limit, then there are other estate planning options for you to explore, with less overall hassle and more overall savings.

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