Couples can save a bundle on estate taxes with this kind of trust.
First, the good news: Most people don't need to think about federal estate tax, which kicks in only when someone dies owning a very large amount of property. The amount of the estate tax exemption depends on the year of death.
|Year||Estate tax exemption|
|2010||No estate tax|
|2011||$1 million unless Congress extends repeal|
If you (or you and your spouse) expect that your estate may owe the tax, consider creating a living trust that will both avoid probate and also save on federal estate tax. If you don't, there may be a big estate tax bill when the second spouse dies. That's because the surviving spouse's estate will include his or her share of the couple's property plus the property inherited from the deceased spouse.
An AB trust, also known as a credit shelter trust, lets a couple pass the maximum amount of property to their children or other beneficiaries after both spouses die, while at the same time ensuring the surviving spouse is financially comfortable during his or her lifetime. It's one of the few times in life you really can have it both ways.
Here's how it works: Instead of leaving property outright to the surviving spouse, each spouse leaves most or all of his or her property to an AB trust. When one spouse dies, the surviving spouse can use that property, with certain restrictions, but doesn't own it outright. That's the reason behind the big tax savings: The property isn't subject to estate tax when the second spouse dies, because the second spouse never legally owned it.
When setting up an AB trust, each spouse names final beneficiaries who will receive the trust's property when the surviving spouse dies. Spouses often name the same people -- their children -- as final beneficiaries, but it's not mandatory.
The surviving spouse has limited power over the assets in the irrevocable trust. The extent of this power depends on the terms of the trust, within certain limits set by the IRS. If a surviving spouse is given more power than IRS rules allow, the surviving spouse becomes the legal owner of the trust property -- exactly what you don't want.
When the maximum powers are granted, the surviving spouse:
In other words, the surviving spouse has the right to use all of the trust principal for what really concerns most older couples: the surviving spouse's health care and other basic needs.
After the death of the surviving spouse, the irrevocable trust property is distributed to the final beneficiaries, chosen by the deceased spouse in the original trust document. The surviving spouse's property is also distributed to her beneficiaries.
Before creating an AB trust, couples should understand what they're getting into. Once one spouse dies, the trust cannot be changed.
Possible drawbacks include:
Given these disadvantages, it's obvious that not all married couples with a combined estate over the estate tax threshold should use an AB trust. It's generally not advisable, at least not without the advice of an experienced estate planning lawyer, for many couples under 60. People in this age group don't want assets to be tied up in a trust if one spouse dies unexpectedly.
Commonly, younger couples create a basic probate-avoidance living trust. When they're older, they revoke it and create an AB trust. And if one spouse unexpectedly dies sooner, the survivor will inherit everything free of estate tax, no matter what the amount. The surviving spouse will probably have years to use the money -- and to find other methods of reducing eventual estate tax.
Other couples who may not need an AB trust include:
Despite its possible drawbacks, an AB trust does work very well for many families. Many older couples conclude that the relatively minor accounting and recordkeeping hassles are outweighed by the benefits.
Cona Elder Law is a full service law firm based in Melville, LI. Our firm concentrates in the areas of elder law, estate planning, estate administration and litigation, special needs planning and health care facility representation. We are proud to have been recognized for our innovative strategies, creative techniques and unparalleled negotiating skills unendingly driven toward our paramount objective - satisfying the needs of our clients.
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