First of all, A-B Trusts have been utilized primarily to protect from Federal Estate Tax (FET) historically. We also use them to plan with blended families. On the death of the first spouse, the Trust splits into two Trusts–the surviving spouse’s A Trust and the decedent spouse’s B Trust. Each Trust is funded with one-half of the community property and the separate property of each spouse. The ultimate distribution is normally in the Trust B section of the Trust and leaving equal shares to all of the children.

The Trust usually also provides that the surviving spouse will receive income from Trust B and he/she may invade principal from Trust B for health, education, support and maintenance. This is called an ascertainable standard.

The clinchers for inequitable consequences are a 5 and 5 Power and the Trust amendment section. The 5 and 5 Power, if included, allows the surviving spouse to receive the greater of $5,000 or 5% of the principal of Trust B annually. The amendment provisions almost always allows for the amendment of Trust A after the death of the first spouse and Trust B becomes unamendable and irrevocable. Very rarely do the husband and wife clients include any limitations on the foregoing provisions in favor of the surviving spouse other than not implementing the 5 and 5 Power.

So, let’s examine a hypothetical to see how this normally pans out for the children.

(Continued from Establishing Trust Together)

Sally and Sam enter into a second marriage. Sally has three children and Sam has two children by prior marriages. They execute an A-B Trust and fund it with community property and each of their own separate property. The Trust provides that the Trust Estate shall be distributed in five equal shares to the children after both spouses are deceased. Sam dies in 2014 and the Trust is divided into Trusts A and B. Over the next six years, Sally invades Trust B’s principal for her health needs, which is allowed by the Trust B provisions. She, as the sole Trustee of both Trusts, distributes all income to herself annually.

In 2017, one of Sally’s children points out the fact that she can change Trust A’s distributions as an amendable Trust. Sally does so and leaves all of her Trust A to her three children, excluding Sam’s children. When Sally dies in 2021, Trust A, which is valued at $1.5 million, is divided among her three children at $500,000 each. Because of Sally’s invasion of Trust B principal over the years, Trust B is only valued at $500,000. Based on five equal shares, each child receives $100,000.

As a result of these Trust provisions, Sally’s children will receive $600,000 each from both Trust A and Trust B and Sam’s children will get $100,000 each from Trust B only. This was all done legally and it happens regularly.

Can this inequitable result be avoided? Yes, with proper provisions and planning. If you are part of a blended family, I would highly advise that we review the Family Trust before one of the spouses is deceased to implement limitations, restrictions and changes where necessary. It will help avoid confusion, misunderstanding and above all, the inequitable division of the Trust estate among the children.

Please call or email Hannah for an appointment at (858) 792-0909 or jes@jackstephens.com and Asset Protect the inheritance for your children.