The A-B trust strategy has long been a staple in the world of estate planning to help minimize estate taxes. And even with the increase in the Federal estate tax exemption and the creation of portability of the estate tax exemption, A-B trust planning is still relevant for very high-net-worth clients, and those who may face a lower state estate tax exemption.
However, a significant complication of A-B trust planning occurs when the only (or primary) asset available to fund the trust is a retirement account such as an IRA, given the common desire to obtain “stretch IRA” treatment to minimize taxable distributions from an inherited IRA.
Fortunately, though, the “see-through” trust rules do allow at least some types of A-B trusts to still obtain stretch IRA treatment, particularly in the case of bypass trusts or (properly drafted) QTIP marital trusts, even when created as a testamentary. On the other hand, naming marital trusts or even revocable living trusts outright can result in a total loss of stretch treatment for an inherited IRA.
In addition, it’s notable that even where the see-through trust rules do allow for the stretch of an inherited IRA, the income tax treatment will often be less favorable than naming beneficiaries outright (due to the compressed trust tax brackets). As a result, anytime an A-B trust is being considered as the beneficiary of an IRA or other retirement account, it’s crucial to weigh the non-tax (and potential estate tax) benefits against the likely income tax disadvantages!