Is An AB Trust Right For You?

Deciding whether an AB Trust fits your estate plan depends on factors like tax exposure, asset protection, and inheritance goals. While it once played a crucial role in minimizing estate taxes, legal changes have made it less necessary for many families. Understanding its benefits, drawbacks, and alternatives helps in determining if it aligns with your financial and legacy planning needs.

What Is an AB Trust?

An AB Trust is a type of trust used in estate planning to reduce estate taxes and preserve wealth for beneficiaries. It is specifically designed for married couples and functions by splitting into two sub-trusts upon the death of one spouse.

Trust A (Survivor’s Trust) remains under the control of the surviving spouse, allowing them to manage and use the assets within it. Trust B (Bypass Trust), also known as the Decedent’s Trust, is irrevocable and holds the deceased spouse’s assets for the benefit of designated heirs. The assets in Trust B are not included in the surviving spouse’s estate, preventing them from being subject to estate taxes upon their death.

AB Trusts were commonly used before the federal estate tax exemption increased significantly. They ensured that both spouses could fully utilize their individual tax exemptions, preventing a large portion of the estate from being taxed when the second spouse passed away. However, changes in tax laws, such as the introduction of portability, have made them less essential for some couples. Despite this, AB Trusts still provide benefits such as asset protection, creditor protection, and ensuring that children from previous marriages inherit a portion of the estate.

What Key Insights Should I Have About A-B Trusts?

An A-B Trust helps married couples reduce estate taxes, protect assets, and ensure inheritance control. While tax law changes have made them less essential, they still offer benefits like asset protection and structured wealth transfer. Here are the key insights:

1. Tax Reduction Strategy – AB Trusts were primarily created to help married couples minimize estate taxes by fully utilizing both spouses’ estate tax exemptions. When the first spouse dies, the assets in the Bypass Trust (Trust B) are excluded from the estate of the surviving spouse, reducing taxable assets upon their death.
2. Split Structure Upon First Death – When one spouse passes away, the trust divides into Trust A (Survivor’s Trust) and Trust B (Bypass Trust). The surviving spouse controls Trust A but cannot alter Trust B, which is locked in for heirs.
3. Limited Access to Bypass Trust – The surviving spouse may have restricted access to Trust B assets. They can often use income generated by Trust B, but they typically cannot sell or distribute principal assets unless specifically allowed by the trust document.
4. Not Always Necessary Under Current Tax Laws – With the federal estate tax exemption currently exceeding $12 million per individual (subject to change), most estates do not owe estate taxes. The introduction of portability allows a surviving spouse to use the deceased spouse’s unused exemption without needing an AB Trust.
5. Still Useful for Asset Protection – Despite tax law changes, AB Trusts remain valuable for asset protection. Trust B assets are shielded from creditors, lawsuits, and potential remarriage complications involving the surviving spouse.
6. Ensures Inheritance for Children from Prior Marriages – AB Trusts are often used in blended families to secure assets for children from previous marriages. The surviving spouse cannot disinherit the children from the deceased spouse’s portion of the trust.
7. Irrevocability of the Bypass Trust – Once the first spouse dies, Trust B becomes irrevocable, meaning its terms cannot be changed. This ensures that the deceased spouse’s wishes are honored, but it may limit flexibility if financial circumstances change.
8. Potential Administrative Complexity – Managing an AB Trust can require ongoing legal and accounting work, including separate tax filings for Trust B. The complexity may not be necessary for estates that fall below the estate tax threshold.
9. Alternative Estate Planning Options – Instead of an AB Trust, some couples opt for a Disclaimer Trust, which provides similar benefits but allows the surviving spouse to decide whether to fund the Bypass Trust based on tax laws at the time of death.
10. State-Level Considerations – Some states have their own estate or inheritance taxes with lower exemptions than federal law. Even if a couple’s estate is below the federal exemption, an AB Trust may still be beneficial for state tax planning in states with separate estate tax rules.

Understanding these insights helps determine whether an AB Trust aligns with estate planning goals, financial circumstances, and current tax laws.

How Does an AB Trust Work in Practice?

An AB Trust functions by splitting into two trusts when the first spouse dies, ensuring tax efficiency and controlled inheritance distribution. Here’s how it works step by step:

1. Creation of the Trust – A married couple establishes an AB Trust during their lifetime, placing their assets into the trust. They serve as co-trustees and have full control while both are alive.
2. Death of the First Spouse – When one spouse passes away, the trust automatically divides into:

• Trust A (Survivor’s Trust): Holds the surviving spouse’s assets. They retain full control and can use these assets freely.
• Trust B (Bypass Trust): Holds the deceased spouse’s assets, up to the estate tax exemption limit. The surviving spouse may receive income or limited distributions but cannot alter beneficiaries or sell assets unless permitted.

This structured approach ensures wealth preservation, tax efficiency, and controlled inheritance distribution while protecting assets from external claims.

Are AB Trusts Still a Smart Choice Today?

Yes, AB Trusts can still be beneficial, but they are not as essential as they once were due to changes in tax laws. The decision depends on individual estate planning needs, tax exposure, and family circumstances.

1. Federal Estate Tax Exemption Has Increased – The estate tax exemption is currently over $12 million per individual (subject to change). Most estates fall below this threshold, making AB Trusts unnecessary for tax savings.
2. Portability Eliminates Some Tax Benefits – Portability, introduced in 2011, allows a surviving spouse to inherit the deceased spouse’s unused estate tax exemption without needing an AB Trust. This simplifies estate planning for many couples.
3. Still Useful for Asset Protection – AB Trusts protect assets from creditors, lawsuits, and remarriage risks. The Bypass Trust ensures that the deceased spouse’s assets are preserved for intended heirs.
4. Essential for Blended Families – If a couple has children from previous marriages, an AB Trust prevents the surviving spouse from disinheriting them, ensuring assets go to the intended beneficiaries.
5. State-Level Estate Taxes May Apply – Some states have lower estate tax exemptions than the federal level. In these cases, an AB Trust can still reduce or eliminate state estate taxes.
6. Loss of Step-Up in Basis – When assets pass through an AB Trust, heirs may not receive a step-up in basis at the second spouse’s death, potentially leading to higher capital gains taxes when assets are sold.
7. Requires More Administration – AB Trusts involve separate tax filings, legal fees, and ongoing management, which can be complex and costly if estate tax savings are not a priority.

When Is an AB Trust Still a Smart Choice?

• High-net-worth couples who exceed estate tax exemption limits.
• Blended families where asset distribution needs to be controlled.
• Residents of states with estate or inheritance taxes that apply at lower thresholds.
• Couples wanting asset protection from creditors or remarriage risks.

For many families, simpler options like a Disclaimer Trust or outright portability may be more practical. Reviewing current tax laws and personal estate planning goals is essential before choosing an AB Trust.

What Do Recent Estate Tax Law Changes Mean for AB Trusts?

Recent estate tax law changes have significantly reduced the need for AB Trusts in many cases, but they still serve specific estate planning purposes. The key changes affecting AB Trusts include:

1. Higher Federal Estate Tax Exemption – The estate tax exemption is currently over $12 million per individual ($24 million for married couples). This means most estates do not owe federal estate tax, making the primary tax-saving function of AB Trusts less relevant.
2. Portability Simplifies Estate Tax Planning – Portability, introduced in 2011, allows a surviving spouse to use the deceased spouse’s unused exemption without needing an AB Trust. This change makes it easier to transfer wealth without complex trust structures.
3. State Estate Taxes Still Apply in Some States – Some states have their own estate or inheritance taxes with lower exemption limits. AB Trusts remain useful in these states for minimizing tax liability.
4. Loss of Step-Up in Basis for Bypass Trust Assets – When assets are placed in a Bypass Trust (Trust B), they do not receive a step-up in basis when the surviving spouse dies. This can result in higher capital gains taxes for heirs when they sell inherited assets.
5. Increased Trust Administration Costs – AB Trusts require separate tax returns, legal compliance, and administrative work. If the tax benefits are no longer necessary, the costs of maintaining the trust may outweigh the benefits.
6. Alternatives Offer More Flexibility – A Disclaimer Trust allows the surviving spouse to decide whether to fund a Bypass Trust based on tax laws at the time of death. This provides flexibility without forcing an irreversible trust split.

What Are the Benefits and Drawbacks of Choosing an AB Trust?

An AB Trust offers tax-saving advantages and asset protection but comes with administrative complexities. Understanding its benefits and drawbacks helps in deciding whether it is the right estate planning tool.

Benefits of an AB Trust

1. Estate Tax Reduction – Assets placed in the Bypass Trust (Trust B) are excluded from the surviving spouse’s estate, reducing or eliminating estate taxes when they pass away.
2. Preserves the Deceased Spouse’s Estate Tax Exemption – Even if the surviving spouse’s assets grow beyond estate tax limits, Trust B ensures that the deceased spouse’s exemption is used, preventing higher taxation.
3. Asset Protection from Creditors – Trust B assets are shielded from creditors of the surviving spouse, providing financial security for designated beneficiaries.
4. Ensures Inheritance for Children from Prior Marriages – The surviving spouse cannot change the beneficiaries of Trust B, ensuring that assets are distributed according to the deceased spouse’s wishes, which is critical in blended families.
5. Protects Against Remarriage Risks – If the surviving spouse remarries, assets in Trust B remain locked for the original heirs, preventing unintended inheritance shifts.
6. Potential State Estate Tax Savings – Some states impose estate or inheritance taxes at lower thresholds than federal limits. An AB Trust helps reduce state-level taxes.
7. Provides Lifetime Income for the Surviving Spouse – While the surviving spouse cannot control Trust B, they often receive income from its assets, ensuring financial stability.

Drawbacks of an AB Trust

1. No Longer Necessary for Many Couples – The federal estate tax exemption is now over $12 million per person. Most estates do not exceed this threshold, making AB Trusts unnecessary for tax savings.
2. Loss of Step-Up in Basis for Bypass Trust Assets – Assets in Trust B do not receive a second step-up in basis when the surviving spouse dies. This can lead to higher capital gains taxes for heirs if they sell inherited property.
3. Restricted Access for the Surviving Spouse – The surviving spouse has limited control over Trust B. They can usually use income but not principal assets, which may cause financial challenges.
4. Complexity and Ongoing Costs – AB Trusts require:

• Separate tax filings for Trust B.
• Accounting and legal fees to maintain compliance.
• Administrative oversight, which may be unnecessary if tax savings are not a concern.

What Makes an A-B Trust Different From Other Trust Options?

An A-B Trust stands out from other trust types due to its dual-trust structure and estate tax benefits for married couples. Unlike other trusts, it ensures that assets are divided upon the first spouse’s death, providing tax efficiency, inheritance protection, and creditor shielding. Here’s how it compares to other common trust options:

1. A-B Trust vs. Revocable Living Trust

• Key Difference: An A-B Trust splits into two trusts upon the first spouse’s death, while a Revocable Living Trust remains a single trust under the surviving spouse’s control.
• Tax Implications: An A-B Trust helps reduce estate taxes by sheltering the deceased spouse’s exemption, whereas a Revocable Living Trust does not provide estate tax advantages.
• Control: The surviving spouse has limited control over the Bypass Trust (Trust B) in an A-B Trust, whereas they retain full control in a Revocable Living Trust.

2. A-B Trust vs. Disclaimer Trust

• Key Difference: A Disclaimer Trust allows the surviving spouse to choose whether to fund a Bypass Trust (Trust B), while an A-B Trust mandates an automatic split at the first spouse’s death.
• Flexibility: A Disclaimer Trust provides more flexibility based on current tax laws, while an A-B Trust is irrevocable once Trust B is created.
• Administrative Burden: A Disclaimer Trust may involve fewer tax filings and legal costs than an A-B Trust, making it a simpler alternative.

3. A-B Trust vs. QTIP Trust (Qualified Terminable Interest Property Trust)

• Key Difference: A QTIP Trust allows the surviving spouse to receive all income from the trust but prevents them from changing final beneficiaries. An A-B Trust limits access to the Bypass Trust (Trust B) but allows full control over Trust A.
• Use Case: QTIP Trusts are often used when one spouse wants to control how assets pass after the surviving spouse’s death, especially in second marriages.
• Estate Tax Treatment: Both QTIP and A-B Trusts help minimize estate taxes, but a QTIP Trust qualifies for the marital deduction, delaying estate taxes until the second spouse dies.

4. A-B Trust vs. Irrevocable Life Insurance Trust (ILIT)

• Key Difference: An ILIT is specifically designed to hold life insurance policies outside of an estate, while an A-B Trust handles a broader range of assets.
• Estate Tax Planning: An ILIT removes life insurance proceeds from the taxable estate, whereas an A-B Trust reduces taxes by using both spouses’ exemptions.
• Control Over Assets: The A-B Trust allows the surviving spouse some access to Trust B income, while an ILIT does not permit the insured or their spouse to control trust assets.

5. A-B Trust vs. Charitable Remainder Trust (CRT)

• Key Difference: A CRT provides income to beneficiaries for a set time, then donates remaining assets to charity, while an A-B Trust splits assets between the surviving spouse and heirs.
• Tax Benefits: A CRT offers immediate charitable deductions and can reduce capital gains taxes, whereas an A-B Trust focuses on estate tax reduction.
• Best For: CRT is ideal for those with philanthropic goals, while an A-B Trust prioritizes protecting family wealth.

What Other Trusts Can Serve Similar Purposes as an AB Trust?

Several trust options offer similar benefits to an AB Trust, such as estate tax savings, asset protection, and inheritance control. While AB Trusts were once the go-to solution for reducing estate taxes, changes in tax laws have made other trusts more practical in many situations. Here are some alternative trusts that serve similar purposes:

1. Disclaimer Trust

• Purpose: Provides tax flexibility while preserving the ability to create a bypass trust if needed.
• How It Works: The surviving spouse has the option to disclaim assets, which then move into a Bypass Trust for tax benefits. If no disclaimer is made, all assets remain with the surviving spouse.
• Best For: Couples who want estate tax protection only if necessary, avoiding the mandatory split of an AB Trust.

2. Qualified Terminable Interest Property (QTIP) Trust

• Purpose: Ensures that a surviving spouse receives income from the trust while protecting assets for specific heirs (e.g., children from a previous marriage).
• How It Works: The surviving spouse cannot change final beneficiaries but can receive trust income for life. Upon their death, remaining assets pass to designated heirs.
• Best For: Couples in blended families where one spouse wants to control asset distribution after their partner’s death.

3. Credit Shelter Trust (CST)

• Purpose: Protects assets from estate taxes by using the first spouse’s tax exemption while allowing the surviving spouse to benefit from the trust.
• How It Works: Similar to an AB Trust, but it focuses only on sheltering assets from estate tax without requiring a split into two separate trusts.
• Best For: Couples with large estates who still need tax-efficient wealth transfer strategies.

4. Revocable Living Trust

• Purpose: Avoids probate and provides estate planning flexibility without estate tax benefits.
• How It Works: Assets remain under the control of the grantor(s) and transfer directly to beneficiaries upon death without going through probate.
• Best For: Couples with smaller estates who do not need estate tax planning but want a streamlined inheritance process.

5. Spousal Lifetime Access Trust (SLAT)

• Purpose: Provides estate tax reduction while allowing the spouse to access trust assets.
• How It Works: One spouse creates the trust and transfers assets, removing them from the taxable estate while allowing the other spouse to benefit from income distributions.
• Best For: High-net-worth individuals looking to reduce estate taxes while ensuring financial security for their spouse.

6. Marital Deduction Trust

• Purpose: Defers estate taxes until the second spouse’s death while ensuring asset control.
• How It Works: Assets transfer tax-free to the surviving spouse under the marital deduction, but they are taxed when the second spouse passes.
• Best For: Couples where estate tax is a concern, but flexibility is needed.

7. Irrevocable Life Insurance Trust (ILIT)

• Purpose: Removes life insurance proceeds from the taxable estate while providing liquidity for estate taxes or inheritance.
• How It Works: The trust owns the life insurance policy, preventing the proceeds from being included in the estate of either spouse.
• Best For: High-net-worth families who want to avoid estate taxes on life insurance payouts while securing financial support for heirs.

Could an AB Trust Be the Best Fit for Your Estate Planning?

Yes, an AB Trust can be the best fit for estate planning in certain situations, but it is no longer necessary for many families due to changes in estate tax laws. Whether it is the right choice depends on factors such as estate size, tax exposure, and inheritance goals.

When an AB Trust is the Best Fit

1. High-Net-Worth Estates – AB Trusts are beneficial for couples whose combined estate exceeds the federal estate tax exemption (currently over $12 million per person). They help reduce estate taxes by preserving both spouses’ exemptions.
2. Blended Families – If a couple has children from previous marriages, an AB Trust ensures that the deceased spouse’s assets go to their chosen beneficiaries, preventing disinheritance by the surviving spouse.
3. Asset Protection Needs – Assets in the Bypass Trust (Trust B) are protected from creditors, lawsuits, and remarriage risks, ensuring financial security for designated heirs.
4. State-Level Estate Tax Planning – Some states impose estate or inheritance taxes at lower exemption levels than federal law. In such states, an AB Trust can reduce state tax liability.
5. Control Over Asset Distribution – Once the Bypass Trust is funded, its terms cannot be changed by the surviving spouse. This prevents unintended asset distribution or misuse.

When an AB Trust May Not Be Necessary

1. Estate Falls Below the Tax Exemption Threshold – If a couple’s estate is valued below the federal estate tax exemption, an AB Trust provides no tax benefit and may create unnecessary complexity.
2. Portability Offers a Simpler Solution – Portability allows a surviving spouse to use the deceased spouse’s unused estate tax exemption without requiring an AB Trust, making estate planning simpler.
3. Heirs Prefer a Step-Up in Basis – Assets in the Bypass Trust do not receive a second step-up in basis, leading to higher capital gains taxes when sold by heirs. If asset appreciation is significant, a Revocable Living Trust or Disclaimer Trust may be more tax-efficient.
4. Avoiding Administrative Complexity – AB Trusts require:

• Separate tax filings for the Bypass Trust.
• Legal fees to maintain compliance.
• Trust administration that may not be necessary if estate tax savings are not a priority.