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The ABC Trust Structure Would Have Worked for Cinderella

Trusts, as we know them, have been around for hundreds of years and started under English law before America existed. However, trusts have only become popular with the American middle class for a couple of decades. Traditional structures don't always fit today's families.

An ABC trust is a very traditional trust structure that is used when a married couple wants to make sure that the children of the marriage or a prior marriage cannot be disinherited following his / her death. For example, if Cinderella's father had created an ABC trust, Cinderella would have been entitled to more rights and benefits of her father's inheritance, and the cruel stepmother could not have disinherited her.

The ABC stands for the three trusts that come into being at the first death: one is called "A", one is called "B" and one is called "C." The A Trust represents the surviving spouse's assets. The B trust represents the deceased spouse's assets and will pass estate tax free at the time of the surviving spouse's death. The C trust saves no taxes, but only exists for purposes of protecting the childrens' future inheritance. The B and C Trusts cannot be rewritten to disinherit anyone after the first spouse dies. The surviving spouse can usually use the assets of all three trusts during his / her lifetime, but cannot lose the assets of the B and C trusts to creditors or remarriage events.

However, in families that are not concerned about children from prior marriages or a spouse who cannot be trusted to protect the family assets, the ABC trust structure can backfire in a couple of ways:

1) Inconvenience . Imagine you have just lost your spouse and you go to the attorney to find out what you should do about the trust. The attorney tells you that you must divide the assets into two parts, your spouse's half and your half. You can do whatever you want with your half of the money, but you are limited to what you can do with your spouse's money for the rest of your life. Additionally, you must now file tax returns for two or three trusts instead of just one. Finally, you must answer to your children about how you are investing and spending their future inheritance. They can sue you if you break the rules.

2) Capital Gains Tax. Upon the death of the Surviving Spouse, the "A" and "C" Trusts enjoy a full step-up in cost basis which means that no one has to pay capital gains tax on the increase in value of the assets when they are sold. The "B" Trust does not get this step-up, so it may be exposed to capital gains tax upon the sale of the assets.

3) Irrevocable. The "B" and "C" Trusts are irrevocable. That means they cannot be changed without consent of all beneficiaries and a court order. If circumstances change, this could feel restrictive.

So what is the alternative? More and more married couples are using a more flexible approach. It is called a Disclaimer Trust . Disclaimer Trusts allow the surviving spouse to choose whether or not it makes sense to fill up the "B" Trust to avoid estate tax at the second death rather than being forced to do so. If we make that decision today instead of at the time of the first death, we do not have all the information we need. We don't know what the tax law will be or how much money we may have by then or even if we want to change the plan. This Disclaimer Trust requires the trustee to be responsible enough to make this important tax-driven decision within 9 months of the first spouse's death. It is not a great structure if the surviving spouse has gambling addictions or can't be trusted to handle money.

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