Last year, House Democrats proposed cutting the federal estate- and gift-tax exemption nearly in half to help fund a sweeping budget and spending package. Even though the exemption ultimately remained unchanged (12.06 million per individual and $24.12 million for married couples), it reminded those with larger estates how quickly laws can change and, thus, how invaluable proper planning can be.
For married couples looking to lock in today's limit without sacrificing access to their assets, one option to consider is a spousal lifetime access trust (SLAT), which is irrevocable and provides payouts to the beneficiary spouse while excluding the trust's assets from the donor (or grantor) spouse's gross taxable estate.
Let's look at how SLATs work and what to consider before potentially creating one.
- The donor spouse gifts cash, life insurance, marketable securities, real estate, or other assets of which he or she is the sole owner to a SLAT and reports it on his or her gift tax return. (Those who reside in one of the nine community property states—Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin—may first need to convert community property assets into separate property assets, typically via a so-called partition agreement.)
- Once the SLAT is funded, the beneficiary spouse can request distributions of income or principal—from which the donor spouse too may benefit, albeit indirectly.
- Upon termination of the SLAT, typically at the death of the beneficiary spouse, the remaining trust assets pass to the remainder beneficiaries named in the trust document.
For example, say Sarah and Neil have joint and separate assets totaling $30 million, which are likely to further appreciate while they're still alive. Were they to transfer $12.06 million each into two SLATs benefiting each other (see "Dual SLATs," below), they would be able to exclude the full $24.12 million—plus any future appreciation and income—from their taxable estates while still benefiting from those assets. They would then have available their remaining $5.88 million in shared assets, plus their SLAT distributions, to support their ongoing income needs.
SLATs may seem like a way to have your cake and eat it, too, but there are risks.
First and foremost, if your spouse suddenly passes away, you lose your indirect access to her or his SLAT payouts. The same is true in the case of divorce, unless you include a provision that states your trust is for the benefit of your current and future spouses, in which case you can regain indirect access to the assets once you remarry.
Be aware, too, that assets held in a SLAT do not receive a step-up in cost basis at the donor spouse's death, potentially increasing the capital gains tax liability to the remainder beneficiaries.
A third-party trustee is often a good idea for trusts of substantial size, but it's perhaps even more favorable in the case of SLATs. That's because if the beneficiary spouse serves as trustee, distributions must be limited to the health, education, maintenance, and support (HEMS) standard—which is determined at the SLAT's creation and cannot be changed—whereas a third-party trustee has more discretion and could increase distributions above HEMS, if warranted.
That said, if you do name your beneficiary spouse as the trustee, you can add a provision that gives her or him the option of appointing an independent trustee. Another popular trust clause—known as the "5 or 5 power"—allows the beneficiary spouse to annually withdraw up to $5,000 or 5% of trust assets, whichever is greater, in addition to HEMS.
Mind the complexities
While changes in tax law are hard to predict, a SLAT may be an effective wealth-transfer strategy to consider while the lifetime gift and estate exemption remains at historically high levels. However, a SLAT strategy should be undertaken only with the help of an experienced estate planning attorney, who can determine if it makes sense for your personal circumstances and help guide you through some of the more nuanced legal complexities.
If you and your spouse both want to create a SLAT to benefit the other, beware the so-called reciprocal trust doctrine, which states that spouses cannot create substantially similar trusts. Any trusts found to be in violation of the doctrine will be ignored for federal tax purposes.
To ensure that your and your spouse's SLAT documents have enough differences, consider drafting the documents at different times, naming different trustees and remainder beneficiaries, and providing different termination provisions, among other approaches. An estate planning attorney can help ensure you don't run afoul of any tax laws.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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