You have likely seen the headlines about potential changes to the federal estate and gift tax laws in the coming years. While it’s unclear what changes will ultimately be made; the uncertainty has people exploring different tax strategies to take advantage of the current tax exemptions. One such strategy is a Spousal Lifetime Access Trust (SLAT).
With the exemption amount currently at an all-time high, the majority of Americans are not affected by federal estate taxes. However, this provision of the law “sunsets” at the end of 2025. Unless new legislation is passed, on January 1, 2026, the federal estate tax exemption amount will drop to an inflation adjusted amount of $6.2 million per person ($12.4 million per married couple). This could expose individuals to federal estate taxes up to 40%, depending on the size of the estate.
Typically, irrevocable trusts have been used in estate plans to shelter the maximum amount of assets from estate tax at the grantor’s (or individual’s) death. Rather than wait until their passing, some individuals elect to utilize this strategy during life to lock-in a significant amount of their current exemption as a hedge against future decreases in the exemption amount.
The SLAT allows one spouse (donor spouse) to contribute assets to an irrevocable trust for the other spouse (beneficiary spouse) for his/her lifetime. The beneficiary spouse has access to the trust income and also may receive distributions of trust principal for his/her health, education, maintenance and support, while the donor spouse is still alive. Since this trust is in effect while the donor spouse is still alive, the donor spouse can still indirectly benefit from the trust. At the beneficiary spouse’s death, the assets will distribute to your remainder beneficiaries (usually children or grandchildren) either outright or in trust. The assets gifted to this trust are removed from both yours and your spouse’s estates and are not subject to federal estate tax.
In many situations, each spouse will create and fund a SLAT for the benefit of the other spouse. However, the terms of the trusts and the assets contributed to the trusts must not be the same. If they are, it could violate what is known as the Reciprocal Trust Doctrine, which would cause the gifts to be disallowed under IRS rules.
• It allows the beneficiary spouse to request distributions of income and principal to maintain the couple’s accustomed manner of living (maintain lifestyle)
• For residents of states that still assess their own state estate/inheritance tax, it can remove assets that would be subject to the tax
• If the trust is structured as a “Grantor Trust” for income tax purposes, the trust will not pay any income tax. The donor spouse will be responsible for paying all of the income tax liability on the trust, which in turn allows the trust assets to grow without being reduced by income taxes.
• If the beneficiary spouse dies before the donor, the donor spouse loses indirect access to the trust assets. However, the trust assets will continue to benefit the donor spouse’s children and grandchildren by remaining in trust or being distributed outright to them.
• One major concern is divorce. This concern can be mitigated, as the trust can contain language that in the event of divorce, the beneficiary spouse’s interest in the trust is terminated.
This strategy can be useful for married couples who are concerned about changes in the federal estate tax exemption amount and/or federal estate tax rate. Please consult your attorney or private wealth advisor for more details and specifics on a SLAT and how it might benefit you.
By Joseph E. Cleveland, CFP®
Senior Vice President & Private Wealth Advisor, Trust
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2022 Second Quarter Review and Commentary
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