Does your estate plan need a spousal lifetime access trust?

In this era of high lifetime estate tax exemptions, more couples are turning to spousal lifetime access trusts, or SLATs, as a tool to maximize transfer tax savings. As of 2022, the lifetime estate tax exemption exceeds $12 million per person. However, we can't fully rely on this number because it's expected to return to $5 million at the end of 2025 if no new laws are passed. Moreover, Congress continues to debate whether to reduce the exemption before the sunset date.

As a result, many high-net-worth taxpayers trying to plan their estates want to take advantage of the high estate exemption amount but aren't ready to immediately gift such a large share of their assets. For these taxpayers, a SLAT is becoming a popular solution.

What is a SLAT?

A SLAT—also known as a lifetime credit shelter trust or a dynasty trust—is an irrevocable trust that's used for lifetime gifting. SLATs are used to remove assets from an individual's taxable estate while providing a back door to income for their spouse during their lifetime.

Typically used as a planning technique between married couples, the trust can also be set up in other relationships, such as between siblings. Distributions may also be made to the grantor's children and other heirs. SLATs can be structured to hold various asset such as business interests, real estate and life insurance.

How does a SLAT work?

Setting up a SLAT takes a few steps. First, the grantor spouse establishes an irrevocable trust naming the other spouse as beneficiary along with children, grandchildren or other chosen beneficiaries.

Once established, the grantor spouse makes an irrevocable gift of assets to the trust from their separately owned property. Both the gift tax annual exclusion—which was $15,000 in 2021 and is $16,000 in 2022—and the gift tax exemption, which is currently $12.06 million, can be used.

After the gift has been made, trustees will be able to make distributions of trust income and principal to the beneficiary spouse and potentially their descendants for ascertainable standards—such as health, education, maintenance and support—or for other potential discretionary reasons.

A gift tax return must be filed to report the transfer and start the statute of limitations for auditing. If structured properly, the remaining trust assets will pass estate tax-free to the grantor spouse's descendants once the grantor spouse and the beneficiary spouse pass away.

For example, let's say Chip and Daisy Gerber have been married for 15 years and have a combined net worth of $22 million from their small business. They worry about possibly high estate taxes but aren't ready to gift away large portions of their estate, especially because it consists mostly of their illiquid business. Also, their children are still minors. Given these inputs, the Gerbers' wealth planner suggests forming a SLAT following these steps.

1. As the grantor spouse, Chip's separate assets of $11 million are moved to the SLAT.
2. During Chip's lifetime, $5.5 million in distributions are made from the $11 million SLAT to Daisy, the beneficiary spouse.
3. After Chip and Daisy both pass way, the remainder of the trust, which is $46,509,127, passes to their heirs. These numbers are based on the following assumptions:

• A growth rate of 4%
• An income rate of 3%
• An estimated 2% of income distributed to Daisy annually
• Daisy's passing happens in 25 years

Who can serve as trustee?

While it's possible for the beneficiary spouse to serve as trustee, it's important to make sure their power to make distributions is limited. A beneficiary serving as a trustee with the ability to make broad distributions to themselves beyond the standards of health, education, maintenance and support could trigger the inclusion of the trust assets in their taxable estate. In addition, distribution rights that are too broad may erode the creditor protections the trust is designed to provide. Both outcomes would negate the benefits of the trust.

Because of the rocky landscape of estate inclusion—as well as creditor protection and navigating the possibility of a marriage that may become less than harmonious over time—it's a good idea to consider selecting a corporate trustee for a SLAT.

What are the advantages of a SLAT?

There are plenty of benefits to using a SLAT.

• It's an effective strategy for grantors who can afford to make a large gift, but who also want to be sure they can access funds in the future if needed.
• The beneficiary spouse or children can act as co-trustees of the trust.
• The grantor spouse's taxable estate is reduced because the value of the trust assets isn't included at time of death.
• Future appreciation on the trust assets can be shifted to the trust beneficiaries without any gift or estate tax consequences, which is ideal for highly appreciating property.
• If the trust is properly structured as a legacy trust, it may provide support for heirs for multiple generations while avoiding estate and generation-skipping transfer taxes.
• The trust may protect beneficiaries from potential creditors, divorce, professional liability or other threats.
• If structured as a grantor trust, the grantor spouse recognizes trust income and pays the related income taxes, further reducing their taxable estate and allowing trust income to compound within the trust to optimize return on investment.

One of the most popular features of a SLAT is that the grantor can retain indirect access to the funds and assets in the trust. This may include sharing an annual distribution that the beneficiary spouse may be entitled to.

Other key features of a SLAT may include:

• Loan director: This gives someone other than the grantor spouse the power, as a nonfiduciary, to loan the grantor spouse trust assets. A loan may be made to the grantor spouse without security but with interest.
• Charitable director: This is someone other than the grantor spouse who is given nonfiduciary power to add charitable beneficiaries to the SLAT. This provides an indirect means of access for the grantor spouse because the charitable director can add a charity to the SLAT and make a donation from SLAT funds. However, a SLAT can't pay a charitable pledge of a grantor spouse.
• Vacation homes: Many SLATs are funded with a vacation home available for the use of the beneficiary spouse and other beneficiaries. The proper structure for this setup would be to hold the vacation home in an LLC that's authorized to do business in the state where the vacation home is located and then transfer some or all interests in the LLC to the SLAT.
• Income tax reimbursement: If the SLAT is a grantor trust, a discretionary income tax reimbursement clause can be included. This would permit the trustee to reimburse the grantor spouse for income tax paid on trust income.

What are the disadvantages of a SLAT?

Before spouses establish a SLAT, they should consider its potential disadvantages.

• The trust is irrevocable.
• The grantor spouse must have sufficient assets titled in their own name to fund the trust.
• If structured incorrectly, trust assets could be subject to creditors or estate taxes.
• Divorce or the death of the beneficiary spouse could result in the grantor spouse losing indirect access to the trust.
• Because assets are moved to the trust, beneficiaries won't receive a step-up in basis on inherited assets.
• If the trust is established as a grantor trust, the grantor will be responsible for income tax payments that can impact cash flow.

What happens in the event of death or divorce?

Upon the beneficiary spouse's death, the grantor spouse no longer has indirect access to the trust assets. Instead, the trust may either be terminated and distributed to the grantor's children and other beneficiaries or continue for the benefit of the grantor's children and other beneficiaries. To alleviate risk and protect against early death of the beneficiary spouse, the grantor spouse can purchase a term life insurance policy on the beneficiary spouse.

In the event of divorce, the separated beneficiary spouse will continue to benefit from the trust while the grantor spouse loses indirect access in the same way they would if the beneficiary spouse passed away while they were still married. A possible solution would be to use a floating spouse provision to name the beneficiary spouse generically as a spouse rather than by name. This way, if the grantor gets divorced, the former spouse would no longer qualify as the beneficiary under the trust.

Is a SLAT right for you?

Whether a SLAT is an appropriate tool for your estate plan is dependent upon your financial situation. Your financial planner can help you weigh the advantages and disadvantages of such a vehicle to determine if it's right for you and your family.

If you have more questions about SLATs and how they can fit into your plan, connect with a First Citizens partner today.