An A-B trust, also known as a bypass trust, is a legal arrangement that allows married couples to avoid estate tax on certain assets when one spouse passes away. When one spouse dies, the estate’s assets are split into two separate trusts, A trust and B trust.
As the size of the estate tax exemption has grown, A-B trusts are less commonly used. However, A-B trusts are still popular because of their ability to shelter assets. Estate planning is an essential part of your overall financial plan, and we’ll unpack the details of this specific type of trust below. It may also behoove you to work with a financial advisor as you explore whether an A-B trust is right for you.
How an A-B Trust Works
In order to set up an A-B trust, a married couple begins by ordering the creation of the trust in their will. This requires specific legal language and is usually handled by an attorney specializing in estate taxes and estate planning.
The A trust, also called the marital trust, holds any assets that can’t be sheltered by estate tax exemption when one spouse dies. The other trust, the B trust or bypass trust, will contain assets up to the amount of the deceased partner’s estate tax exemption.
In order to keep the trusts straight, it may help to think of the A trust as belonging to the spouse who is expected to remain “above the account,” while the B trust is for the spouse who will first go “below the ground.”
When the first spouse dies, the appropriate assets are placed in the B trust. The B trust will ordinarily contain assets up to the in-effect limit for the federal estate tax exclusion. This amount is currently $11.7 million. The A trust will contain the balance of the couple’s assets.
While the remaining spouse lives, the trusts will shelter the assets in them from creditors as well as from any new partners resulting from additional marriages later in life.
When the second spouse dies, the assets in the A trust are included in his or her estate. This ensures that both partners’ estate tax exemptions are used for maximum effect.
After both partners have died, any assets from the estate can stay in the trusts and be used for the benefit of the couple’s heirs. The trusts will shelter the assets from creditors as well as from divorce settlements should any of the couple’s offspring have divorces.
A-B Trust Benefits
The major benefit of an A-B trust is minimized federal estate taxes. If a couple has an estate worth more than the federal estate tax exemption, then splitting assets and sheltering them in the two trusts keeps the estate from being taxed twice, once when the first partner dies and again when the second partner dies. Splitting assets often avoids estate taxes, because each partner’s share is below any the estate tax minimum.
An A-B trust also helps couples avoid having their estate go through probate. And it can protect assets a couple has accumulated from spouses, either the current spouse or later spouses resulting from additional marriages.
An A-B trust arrangement can keep a surviving spouse from changing beneficiaries of a couple’s state. That’s because the B trust is typically an irrevocable trust, terms of which cannot be changed. Sometimes, if a couple has assets that are growing, these assets can be placed in the B trust, so that they will not be taxed until after the second partner’s death.
History of A-B Trust
A-B trusts were once common tools for estate planners but they have become less useful over the past couple of decades. That’s because the estate tax exemption has been raised multiple times. Now, according to the Tax Policy Center, very few estates big enough to pay the tax.
In 2001, when the estate tax exemption was $675,000, U.S. taxpayers filed approximately 110,000 estate tax returns. More than 50,000 of those returns required paying estate tax.
By 2007, the estate tax exemption had been raised in a series of steps to $3.5 million. That year taxpayers filed fewer than 13,000 estate tax returns. Only 5,700 of these paid any estate tax.
In 2020, only a few more than 4,000 estate tax returns were filed. Of these, only 1,900 paid any estate tax. This means that, of the 2.8 million people projected to die in 2020, fewer than 0.1% or one in 1,000, paid any transfer tax on their estates.
An A-B trust can be used to manage wealth transfer taxes as a tool of estate planning for married couples. It’s mostly used for couples with estates valued at more than $11.7 million, the size of the federal estate tax exemption. This use is becoming less common as the estate tax exemption has been raised.
Tips for Estate Planning
- Setting up an A-B trust is complicated and, because of the need for expert legal advice, can be expensive at the start and throughout the trust’s life. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- A-B trusts have to be carefully thought out. Since the B trust is usually an irrevocable trust, that means any assets placed in it won’t be under the control of the surviving spouse. Planners need to make sure they leave enough assets out of the B trust to provide financial support for the surviving spouses.