Difference Between Survivor & Exemption Trusts

Estate planning can be fairly simple or quite complex, depending on the size of your estate and how you want it distributed after your death. One issue you will need to consider is the estate tax (sometimes called the "death tax"). Federal taxes apply to a person's estate in excess of $11.4 million as of 2019.

One way married people can reduce the impact of taxes on a large estate is through the creation of a pair of trusts known as survivor and exemption trusts, or A/B trusts. This arrangement can effectively double the federal exemption.

Creating the Trusts

The survivor and exemption trust arrangement assumes a common scenario for a married couple. First, that upon the death of one spouse, they want the other spouse to inherit the other half of the couple's estate. Then, upon that spouse's death, they want the entire estate to pass to their children.

The way an A/B trust is set up is through the creation of a revocable trust while both spouses are living, which then breaks into a pair of trusts – "A" and "B" – when the first spouse dies. The initial trust is a revocable living trust, which holds the couple's assets in trust for their own benefit and can be modified at any time. This has almost no effect on the couple's day-to-day lives, save that most major assets are listed in the trust's name instead of the individual's.

How a Survivor Trust Works

When the first of the two spouses dies, the first trust formed from the original living trust is a survivor trust. This is a continuation of the original trust, for the benefit of the surviving spouse. However, it only contains that surviving spouse's share of the couple's estate (usually half, plus any personal property). Like the original trust, it is revocable and can be modified at any time.

How an Exemption Trust Works

The second trust created under the estate plan is the exemption trust. This trust – also known as a bypass trust or credit shelter trust – is an irrevocable trust that contains the portion of the estate belonging to the spouse who has died (usually half plus any personal property) and will bypass the surviving spouse and instead be passed to the children upon that spouse's death.

The key is that it also contains the deceased spouse's estate tax exemption, because there has been no direct transfer of property to an inheritor – the surviving spouse – as in a normal will situation. The surviving spouse has access to these assets, if necessary, but does not own them.

How They Work Together

Working together, the survivor and exemption trusts allow the couple to effectively double the exemption on the estate they pass to their children. For instance, if the couple had $40 million in assets, with a standard will, the death of the second spouse would force the children to pay tax on $28.6 million, as they could only claim the $11.4 million exemption of the second spouse.

Through the A/B trust arrangement, the first spouse's $20 million share would be held in the exemption trust and not trigger any federal taxes, while the second spouse's $20 million share would be exempt normally. As with any federal tax situation, estate tax rules may be subject to action by Congress.

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