What is an AB Trust?

An AB trust is a type of living trust set up by spouses to leave behind the wealth of an estate to either their children or other beneficiaries to take advantage of favorable estate tax laws. Instead of one spouse simply leaving the estate to the other in the event of death, an AB trust, also known as a marital bypass trust, calls for the couple to divide up the estate into separate trusts that are passed on to chosen beneficiaries when either spouse dies.

The main advantage of this type of trust is that it allows each spouse to use estate tax exemptions to lessen, or even eliminate, the tax burden for the beneficiaries of the estate. Although the surviving spouse can benefit from income generated by the deceased spouse's trust, the disadvantage of the arrangement is that they have limited ability to control or use the assets of the trust.

If a couple establishes a joint trust, the entirety of the estate immediately goes to one spouse when the other dies. When the surviving spouse dies, the wealth of the estate, if it surpasses the federal estate tax exemption level, is subject to a significant estate tax when it is passed to the children or other beneficiary. This mainly effects families in higher income brackets, meaning the wealthy stand to benefit most from placing inheritance into an AB trust.

In an AB trust, the couple divides its estate and the wealth evenly and distributes it into two trusts, an A trust and a B trust. For example, a couple with an estate of $6 million U.S. would put $3 million into each trust. This split could bring each trust under the federal estate tax exemption level. Using this example, if the husband dies first, his A trust would pass to his children or beneficiaries, and if the amount within fell under the exemption limit it would not be subject to estate tax. The wife could still live on the property of the estate, be entitled to allowances from the A trust as well as any income generated by its assets, and still has access to the funds in her B trust.

When the wife dies, she then would pass her B trust on to her beneficiaries, which can be the same person or people marked for the A trust. Using this exemption as well, the funds in the B trust can also be passed on with little or no estate tax.

There are certain disadvantages to an AB trust. The surviving spouse has only limited access to the funds within the trust of the deceased spouse, and excessive use of those funds could cause scrutiny from the Internal Revenue Service. In addition, the surviving spouse cannot sell any of the property bequeathed by the deceased spouse, meaning that any type of move to a different location would be very difficult.