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Like most married couples, chances are you share the nearly universal concern of ensuring that your better half is well provided for after your death. There are many different ways to ensure that your surviving spouse is well taken care of financially - through insurance, investments, trusts, and other sources of income. One of the most effective ways is through the use of what is commonly called an "A/B" Trust arrangement. This type of trust not only provides a financial resource for your spouse, but it also assures that your assets are ultimately distributed according to your wishes, and that your heirs do not incur any more estate taxes than are absolutely necessary.
As you might guess, an A/B trust actually consists of two trusts - an "A" trust, or appointment trust, and a "B" trust, known as a bypass trust. Under the typical A/B trust arrangement, the maximum amount that can escape estate taxation is transferred to the B trust and the remainder of the estate is transferred to the A trust. There are other A/B trust arrangements available depending on the goals and objectives of the family.
How Does the A Trust Work?
Regardless of the allocation of assets, the A trust is usually set up so that it qualifies for the 100 percent estate tax marital deduction for transfers to a spouse who is a U.S. citizen. The surviving spouse must receive all income generated by the trust. In the typical trust, he or she can also request principal distributions. This means that the assets of the trust may be subject to the surviving spouse's creditors and, of course, at death will be subject to federal estate taxes as well.
The surviving spouse will often hold a general power of appointment over the A trust assets - in other words, he or she can determine how the assets will be distributed upon termination of the trust. This power may be exercisable during life, on death (through a will), or both. The surviving spouse must not lose the power of appointment because of remarriage or any other event. However In other cases, depending on the goals and objectives of the family, the surviving spouse will not have a general power of appointment.
How Does the B Trust Work?
The "B" trust, on the other hand, is designed so that it is not included in the surviving spouse's estate even though he or she benefits from it. It uses all or part of the current estate tax credit that is available to the estate of the first spouse to die.
The B trust may provide income to the surviving spouse or to individuals other than the surviving spouse, such as children, grandchildren, or other beneficiaries, and it may continue on for those beneficiaries after the surviving spouse's death. The surviving spouse may have a limited power to determine who receives the trust's principal at death. The law permits the trust agreement to provide that the surviving spouse has the non-cumulative right to request the greater of $5,000 or 5 % of the value of the trust assets on an annual basis. In addition, the trustee may distribute funds to the spouse under specific circumstances outlined in the trust agreement. In this way, the surviving spouse receives limited access to the trust fund without violating the tax code, thus preserving the federal estate tax advantages associated with the B trust.
So what does this A/B trust arrangement accomplish? A lot. It allows the B trust to "bypass" the surviving spouse's estate at death and thereby avoid federal estate taxes altogether. The trust will then pass intact to their children or other beneficiaries. This arrangement defers the estate tax due on the A trust until the second spouse dies. It also permits the surviving spouse to access the A trust assets which could reduce the size of the trust on the surviving spouse's death. This arrangement decreases the estate taxes owed on the death of the surviving spouse and maximizes the amount that is available for children or other heirs.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.