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Family Trust: Is A/B Trust OK?

Bogleheads • View forum - Personal Finance (Not Investing) - www.bogleheads.org
I am asking as help for a relative, who has a family trust of the A/B type, written several years ago. Details:

Married couple, Total equity in trust including house, cars, brokerage accounts 4.0 Mil + IRAs of each 0.5 and 1.0 Mil = Total 5.5 Mil.

Beneficiaries: If one spouse dies, the surviving spouse inherits it. If both die, (Grown up) kids will inherit.

California: No estate tax

They are stressed out because they have been advised to immediately change the trust to remove the A/B type trust.

I imagine the following potential scenarios.

(1) If one spouse dies now, the trust will divide into two trusts, 2.75 Mil each. No tax impact since the deceased spouse's portion in trust A is well within the individual exemption. However, the basis of the deceased spouse's trust A will never change.

- The two trusts will continue to grow, and the surviving spouse will continue to be the trustee of both. (Right?)

- When the second surviving spouse also dies, the kids will inherit both trusts.

- The surviving spouse's trust B may owe taxes, only if the money has doubled to greater than 5.4 Mil (current exemption amount) but this trust B will have step up cost basis. That will help reduce the tax impact on the kids.

- Kids will owe taxes on the trust A assets above the current cost basis only when they sell the assets and realize the cap gains, but not otherwise at the time of inheritance because the assets are below exemption limit for individual. (Correct?

- If the kids use trust A to withdraw only say 4% per year from it, the tax impact should be minimized, even though trust A will have lower cost basis than trust B.

(2) If both spouses die now, the kids will inherit the current trust as is, with stepped up basis. As the amount is well below the exemption limit, no estate tax.

It seems that they should change the trust, before the assets grow to exceed the exemption limits. Looking at the total assets though, it is not an emergency since the amount in the trust is way below the exemption limits. Comments?
Date: Oct 27, 2016   


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