What Is an A/B trust?
“An A/B Trust” is typically a trust that is:
- Revocable while both settlors are alive (“settlors” are people who created the family trust, the two spouses)
- On the death of the first settlor, splits into two trusts, the “A” trust and the “B” trust
The “A” trust is usually also known as “The Survivor’s Trust.” The Survivor’s Trust gets funded with the Surviving Spouse’s separate property, and their share of the community property.
The “B” trust is usually known as a “bypass trust,” however, I have seen it called at least a half dozen other things. So don’t focus on the name too much. The “B” Trust gets funded with something. What exactly that something is is spelled out in the terms of the family trust, and varies (almost as much as the names of the trust itself vary).
The mile-high overview of these trusts is this: the Surviving Spouse gets to do whatever he or she wants with the assets in the Survivor’s Trust, but has limitations on what he or she can do with the assets in the “B” trust. Most importantly, the Surviving Spouse cannot change the remainder beneficiaries of the “B” trust.
Illustration: H (Husband) and W (Wife) have two kids, C1 and C2. H and W make an A/B family trust. H dies. The trust dictates that on H’s death, 50% of the estate (W’s share) goes into the “A” trust (Survivors Trust) and 50% of the estate (H’s share) goes into the “B” trust (Bypass Trust). During the remainder of W’s life, she’s entitled to spend some of the assets from the “B” trust, but she cannot change the fact that once she too passes away, whatever is left over in the “B” trust WILL be inherited by the two kids, C1 and C2.
What If Your Spouse Died and You Don’t Want the A/B Trust?
I recently helped a widowed client get a Judge’s approval to amend her irrevocable “B” trust. Even to me, that sounds fancy, like it would have to be something that happened in a very large, convoluted estate, possibly involving a castle overlooking a lake.
Sadly, no. It was a very modest estate – a regular single family home, and not many other assets. Here’s what happened: Husband (“H”) and Wife (“W”) created a basic revocable family trust, back in the 1990s. The exemption was well below $1m per person, and I guess their original attorney thought that the “A/B Trust” set up was warranted.
Anyway, the “A/B Trust” mandated that on the death of the first spouse, the entire estate must be split up into two shares, with one share going into a revocable “Survivor’s Trust” and the second share going into an irrevocable “Bypass Trust.” After the second spouse’s death, the remainders of both trusts were to be combined and divided in equal shares between their children. All children were biological to both spouses, and always got along very well.
The husband passed away around 2008, leaving behind the house, some pension plans, and not much else. The wife did nothing, until 2016, when she decided to update her trust, and came to my office.
What should have happened in 2008 is called “trust administration,” when the instructions of the trust should have been followed, splitting the estate into two shares for each one of the subtrusts. However, that didn’t happen. Furthermore, the deceased husband’s 50% share of the community estate was well below the estate tax exemption in that year, and there were zero tax-related reasons to put part of the estate into the irrevocable trust. Because all the children were common to both settlors and got along very well, there was no social reason for the irrevocable trust, either.
Because the husband had passed away before the wife came to me to amend the trust, and the trust had become irrevocable, I could not amend the trust without Judge’s permission. So we filed a Petition asking the Judge to allow us to amend the trust so that it no longer required the subtrust funding, or the “A/B” split. Here is an outline of our argument:
- The tax environment has changed, the deceased spouse’s estate is well below the applicable estate tax exemption, so there’s no tax reason for the trust
- The irrevocable (“B”) trust is very inconvenient since, with half of the house no longer belonging to her, the widow may have a very difficult time refinancing or taking a reverse mortgage on the property, should she need to do so.
- All the children get along well, are the remainder beneficiaries, and consent to the modification – even though their interests will be less protected as a result of said modification.
- Transferring the property into the irrevocable trust will have dire tax consequences: it will negatively affect the basis, the property tax reassessment exclusion, and the capital gains at the time of eventual sale.
- Lastly, funding and ongoing maintenance of the irrevocable trust will result in unnecessary administrative expenses to the family.
Luckily, our arguments made sense and the Judge allowed us to amend the trust, deleting the entire subtrust funding section and allowing for everything to go to the surviving spouse. Unfortunately, it took a lot more of wife’s time, money, and energy than a timely amendment would have – but as they say, better late than never. Plus, even with the expense and hassle of getting a court-approved petition, she was still better off than had she followed the trust instructions and funded the subtrust.
In conclusion, it’s important to revisit your estate plan every 5-10 years, or sooner, if major life changes occur. Please consult with me or another attorney if you have any questions.
Set up a free consultation today