Dear Mr. Miller: My wife and I have an A-B Trust from the late 90’s.
We have about $2.5 million split equally between the house and securities & cash. There is now an $11.2 million death tax exemption. Do we still really need that type of trust?
Death Tax Exemptions: A-B Trusts were all the rage until about 2011. Before then, many couples were very worried about the death tax as there were relatively low death tax exemptions in place. Then in 2011 it jumped up to $5 million and was tied to the cost of living index so that it would increase each year (here’s an historic chart of the exemption amount for the last two decades). In 2017 it had hit the $5.49 million level.
Portability of Exemption: Along with the 2011 $5 million exemption, Congress authorized the surviving spouse to acquire the other spouse’s exemption; thus, effectively raising the limit to twice the exemption amount ($5M in 2011 times 2=$10M). Only a small fraction of couples needed to worry about death tax with an exemption of that amount. The Trump tax bill of late 2017 doubled that amount through 2025. So right now the exemption is $11.2M for one person and over $22M for the couple. With your $2.5M, death taxes are just something about which you probably don’t need to worry.
Disadvantages of A-B Trusts: So should you dump the A-B Trust and convert it to a much simpler approach–a “simple trust?” First, let’s discuss the downsides to the A-B Trust. Oh, you thought there weren’t any? There are several. (1) They cost more to maintain after the first death (and more to split the estate into the two pots). If done correctly, there will be two income tax returns that need to be filed (one for the survivor and one for the decedent’s trust). The tax preparer is going to charge more although income taxes should be essentially the same. The surviving spouse should be creating a financial report annually for the decedent’s trust for the benefit of whomever takes that trust after the survivor dies (probably the children). So either the survivor is going to do that herself (not recommended) or she will have to pay someone to do that. (2) It is more complicated. Instead of having one securities account there will probably be two, instead of having one bank account there will probably be two. The survivor has to take the income (but not the principal) out of the Decedent’s Trust each year. (3) After the death of the survivor there could be a large capital gain tax on the decedent’s trust assets (but there are ways to work around this issue). So everything being equal, it is better not to have to deal with these complexities and costs.
Advantages of A-B Trusts: Now let’s take a look at the benefits of the A-B Trust. Death tax savings is the big one, but for you, we have already established that that is irrelevant. So what other advantages exist. (1) If the survivor runs away with the pool boy (or the 20 year old blonde down the street or the nurse), she can give away everything in the Survivor’s Trust to the pool boy or blonde but, the Decedent’s Trust is much more protected from this behavior. In essence, the Decedent’s Trust increases the odds that the children will wind up with those assets. This feature is often referred to as “Bimbo Protection,” I call it the Groucho Marx Nurse Protection. (2) If the survivor gets into a car accident that is her fault and in which the other driver dies, the Decedent’s Trust generally obtains substantial protection from the lawsuit creditors. Think about the orthopedic surgeon with 5 minor kids who survive him. That lawsuit judgement could be considerably more than whatever amount the surviving spouse has for auto liability insurance. And the surviving family might be looking around for assets from which to satisfy that judgment and take aim at what was inherited from the other spouse. In that case that surviving spouse will be very happy that she has a Decedent’s Trust and not a simple trust.
Conclusion: Are the advantages that overwhelming to cause one to keep the A-B Trust setup? That depends on each person’s individual preference. If the children keep visiting it is unlikely that everything will wind up with the nurse so that tends to resolve issue #1. One can purchase umbrella insurance in multiples of $1M for relatively small premiums. That would decrease the risk with issue #2. But each person has to make his own choice. And, of course, everything I have said is from a California perspective. The laws of other states may be different. So, as always, if you have an A-B Trust consult with an experienced estate planning attorney before you head to the shredder.