Setting up a trust can be complicated but it can be even trickier to unwind one. Many trusts were set up over the years to help protect wealth from estate taxes. But the federal estate-tax exemption has risen steadily in recent years, to $5.25 million, or $10.5 million for couples, from $1 million in 2003. As a result, fewer people risk triggering the tax, and some trusts established in years past are no longer needed. Some wealth managers are suggesting to clients that they terminate so-called AB trusts that were set up to avoid or postpone federal estate taxes. These instruments include an “A” trust, which holds assets for the survivor’s use, and a “B” trust, also called a bypass trust, which sets aside certain assets for heirs. Together they shield the first spouse’s estate from estate taxes, letting the estate grow while the surviving spouse is alive, and then get passed on. AB trusts are relatively easy to unwind when both spouses still are alive, because they still are considered legally revocable during that period. When a spouse dies, however, the trusts become irrevocable.
In other cases, advisors are recommending a “disclaimer” trust, which gives the surviving spouse more control than a straightforward AB trust because the survivor can choose to dismantle the trust entirely. A widow, for example, might decide her estate is never going to be big enough to be taxed by the federal government (though states might have lower estate-tax exemptions). With a disclaimer trust, she could exercise the option not to fund the B trust and avoid having to set up and manage a trust that is irrevocable and limits her use of its assets.
Many advisers are also helping clients terminate qualified personal residence trusts, or QPRTs. These pass ownership of a home, often from a parent to a child while the owner is alive, and the child doesn’t have to pay taxes until the house is sold. Many people set up QPRTs when the federal tax exemption was lower to remove their homes from their estates. Now, with the higher exemption, some families could pay less tax by having the home back in the estate. That way, heirs would pay lower capital-gains taxes when they sell the home, because capital gains would be based on the home’s value at the time of the parent’s death.
