Tax-Saving AB Trusts -P2

 The Surviving Spouse's Rights
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:
  • receives all interest or other income from the trust property
  • may use the property -- for example, he or she can live in a house held in trust
  • may spend the trust property in any amount for his or her health, education, support and maintenance, in his or her accustomed manner of living. (IRS Reg. 20.2041-1(c)(2).)
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.
Drawbacks of an AB Trust
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:
  • Restrictions on the surviving spouse's use of the property. As discussed above, the surviving spouse has only limited rights to use trust property in the irrevocable trust.
  • Expense of legal or accounting help. When one spouse dies, the survivor will need to hire a lawyer or accountant to determine how to best divide the couple's assets between the irrevocable trust and the surviving spouse's revocable living trust. How the property is divided can have important tax consequences.
  • Trust tax returns. The surviving spouse must get a taxpayer ID number for the irrevocable trust and file an annual trust income tax return. Like any tax return, this requires some work.
  • Recordkeeping. The surviving spouse must keep separate records for the irrevocable trust property.
  • Uncertainty about the tax laws. Because Congress is almost sure to tinker with estate tax laws again in the next few years, you may end up wanting to change or revoke a trust you create now.
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:
  • Couples where one spouse is considerably younger than the other. There's generally no need to burden the second spouse with a trust designed to save estate taxes when he or she is likely to live for many years.
  • Many couples with children from prior marriages. There may be concern about conflicts between the surviving spouse and the deceased spouse's children, who must essentially share ownership of property for many years. (See Family Conflicts, below.)
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.
                                                                                                                  Family Conflicts
With an AB trust, there is an inherent possibility of conflict of interest between the surviving spouse and the final beneficiaries. The final beneficiaries may want all the trust property conserved, no matter what the needs of the surviving spouse. But the surviving spouse may want to spend trust principal.
An AB trust works best when the final beneficiaries understand that taking the trouble to create the trust is a generous act by parents. After all, the parents do not benefit themselves, but their inheritors receive much more of the couple's combined estate than they would if the spouses simply left property to each other. The final beneficiaries should also understand that all property in the trust should be available for the surviving spouse.