From all the movies, TV shows, and real-life instances we have experienced, we have all learned that marriage changes a lot of things. Finding true love and making promises of everlasting love and companionship are life milestones.
But no matter how enamored and enraptured you are with your better half, tying the matrimonial knot shifts things around. In the context of this article, it’s not about changes in your personal life. Instead, we will focus on what changes in terms of your finances.
In the United States, there are some privileges and benefits to getting married. Tax benefits are one of them. When estate planning is concerned, the benefits mainly come from federal tax exemptions from estate taxes. And how does one take advantage of this? Through AB Trusts.
The ABC of AB trusts
There are many tools involved in estate planning that can be used to secure the future of your loved ones. AB trusts are used when a married couple wants their assets to be passed on to each other when one passes away.
AB trusts are basically joint trusts that married couples set up to benefit from estate tax exemptions. This is as simple as an explanation can get. To elaborate, this type of trust is created when both spouses fund estate in their names into a joint trust.
Whichever spouse is the first to pass away, the joint AB trusts is split into two. Whatever estate the deceased spouse funded turns into an irrevocable living trust. On the other hand, the surviving spouse’s share of the trust transforms into a revocable living trust. To make it even simpler, let’s take a look at an example:
Let’s assume that John McClane and Hans Gruber are married. An unlikely couple but they make it work. During their marriage, they both acquire wealth separately but decide to fund it into a joint A-B trust. After a long, rich marriage, Hans dies a peaceful death.
Upon his death, his share turns into an irrevocable trust, giving John the ability to access the income for as long as he lives. However, he can’t accept the principal. As far as John’s own share is concerned, he uses it as a revocable living trust.
He can use the income and principal, change the beneficiaries, fund estate in or take some out. When John also passes away, Hans’ trust is distributed among his beneficiaries and so is John’s.
What does the tax come in?
A-B trusts were typically created to reduce federal estate taxes. Each state in the United States has a threshold value over which taxes are applied.
To explain the concept for people completely unaware of what trusts are, here is an easy example:First, let’s take a look at a couple without an AB trust. Larry and Sara have individually accumulated an estate worth $1 million. This makes the total value of their joint assets, $2 million.
When Larry dies, Sara bequests the entire estate, which is not subject to estate tax as due to marital exemption rules. However, upon Sara’s death, she only has her own estate tax exemption. However, the entire $2 million estate will be taxed and not just the leftover amount.
Now let’s consider that Larry and Sara had created an AB trust. In this case, Larry’s $1 million estate goes into Trust A. Since it’s an irrevocable living trust, no estate tax is applied. When Sara dies, her estate will be worth only $1 million even though she can use the income from Larry’s trust. This amount is under the threshold and will not be taxed.
A-B trusts today
When this type of trust was created for the first time, it gave couples a great option to minimize the amount of estate tax. However, since then, there have been major changes that have reduced their popularity.
Today, the federal gift and estate tax exemptions have much higher thresholds. As of now, the basic exclusion amount in the state of New York for deaths occurring on and after 01/01/2020 until 01/01/2021 is $5.85 million. This exact amount is different from state to state.
This means that one person can pass this amount and under without estate tax application. Considering that not many American adults have an estate worth this amount, AB trusts are not usually required but can be useful in some situations.
If you and your spouse think that an A-B trust may be advantageous for your financial situation, you can talk to your estate planning lawyer. They will be able to study your estate and help you determine whether it’s of value for you or not.
