So you are thinking about making a series of gifts protected from gift tax by the annual exclusion, or a large gift sheltered from gift tax by the applicable exclusion amount, but have concerns about losing access to the gifted property or its income if circumstances change. If you are married, one possible solution is a spousal lifetime access trust (SLAT).
What is a SLAT and How Does it Work?
A SLAT is designed to give away property for transfer tax purposes (and possibly for asset protection), while still retaining the ability for distributions to be made to the beneficiary spouse for the benefit of your family unit if the need ever arises.
Of course, if you create a SLAT for your spouse and you divorce, or your spouse dies before you, you generally lose access to the trust property and its income. However, you can provide in the trust document that any interest your spouse has in the trust will terminate upon divorce. You might even provide that if you remarry, your new spouse will have access to the SLAT.
Using Exclusions to Avoid Estate Tax
You can use your gift tax annual exclusion ($17,000 in 2023, $16,000 in 2022) or applicable exclusion amount ($12,920,000 basic exclusion amount in 2023, $12,060,000 in 2022) to make one or more gifts of property to the SLAT that are sheltered from federal gift tax. In addition, the SLAT is designed so that neither you nor your spouse retains any interest that would cause the SLAT to be includable in either of your gross estates for federal estate tax purposes. If the SLAT will be generation-skipping (i.e., it has beneficiaries who are two or more generations younger than you, such as your grandchildren), you may want to allocate your generation-skipping transfer (GST) tax exemption ($12,920,000 in 2023, $12,060,00 in 2022) to the trust to protect it from the GST tax.
A SLAT is generally a variation of a credit shelter bypass trust and can be an irrevocable life insurance trust. It is common for a credit shelter bypass trust created at death to provide the surviving spouse with a right to distributions based on an ascertainable standard of health, education, maintenance, and support (HEMS). However, if your SLAT has a HEMS provision giving your spouse access to the trust while you are alive, it may cause problems for the SLAT. Such an interest could be treated as the right to discharge your legal obligation to provide support to your spouse, which would cause inclusion of the SLAT in your gross estate for estate tax purposes as an interest retained for your life. But if your spouse's interest is limited to distributions at the sole discretion of an independent trustee (perhaps with a HEMS provision for your spouse after your death), this problem should not arise.
Your spouse could have a mandatory right to income from the SLAT without causing the SLAT to be included in either of your gross estates. However, any income retained by your spouse until death (i.e., not consumed or given away) would be included in your spouse's gross estate.
If you want to use annual gift tax exclusions to shelter gifts to the trust, Crummey powers to withdraw gifts to the trust for a short period of time after a gift is made could be given to some beneficiaries, with the hope that such powers would not actually be exercised.
With Life Insurance
A SLAT can be used to hold life insurance while keeping the life insurance proceeds out of your estate and still providing access to the cash value in the policy.
To fund the purchase of life insurance, gifts are made to the trust, possibly using the gift tax annual exclusion or the applicable exclusion amount. The trustee can purchase the life insurance, and the SLAT would be the owner and beneficiary of the life insurance policy. At your death, the life insurance proceeds would not be included in your estate for estate tax purposes. The proceeds would also generally be received by the trust free of income tax.
To access cash values in the policy, the trustee can be given the discretion to take loans and withdrawals from the policy. Generally, a loan is not treated as a distribution and is not taxable. Withdrawals may be free of income tax if they don't exceed the investment in the contract (or basis). Withdrawals and loans may reduce the amount of proceeds received at death. (The rules are not so favorable if the life insurance policy is a modified endowment contract.)
The trustee is also given the discretion to make distributions to your spouse. If the trust has no other taxable income, the distribution is free of income tax to your spouse.
Installment Sale to a SLAT
Another strategy is to sell appreciated property to the SLAT for an installment note. First, you transfer cash and/or other property to the SLAT. This may be a taxable gift except to the extent your applicable exclusion amount is available.
Then you sell appreciated, income-producing assets to the SLAT for an installment note, payable over time, bearing an appropriate applicable federal interest rate. The SLAT will then use trust income to make payments on the note to you.
Since the SLAT is treated as a grantor trust, and trust income is taxed to you for income tax purposes, you and the grantor trust are treated as one taxpayer. Therefore, no gain is recognized for income tax purposes when you sell the appreciated property to the SLAT.
Furthermore, you will have removed the appreciated property (as well as any future appreciation on the property) from your gross estate for estate tax purposes. If you pass away during the term of the installment sale, only the unpaid balance of the installment note would be included in your estate.
Can you create a SLAT for your spouse, while your spouse creates a SLAT for you? You can, but if the trusts essentially provide reciprocal benefits (merely switching you and your spouse as the spouse with access), the trust you create for your spouse will generally be included in your gross estate for estate tax purposes, and the trust your spouse creates for you will generally be included in your spouse's gross estate. However, by making the two trusts sufficiently different, you can avoid this reciprocal trust doctrine. For example, you can provide that one trust also give the spouse with access a limited power to appoint trust assets at death among a group of beneficiaries, while the other trust does not have such a provision.
If you and your spouse are not trustees, and the only distributions that your spouse can receive are at the sole discretion of the trustee, creditors of you and your spouse generally cannot access the trust assets. The trustee cannot be compelled to distribute trust assets to your spouse. So, if needed, trust assets can be retained in the trust, or the trust can provide that distributions can be made to other beneficiaries, outside the reach of you and your spouse's creditors.
Note: Your creditors may be able to reach trust assets if you transferred the property in anticipation of claims by your creditors, if you retained insufficient assets, or if the transfers to the trust left you insolvent.
Property held in a SLAT will avoid probate and the costs and delays often associated with probate.
As noted above, a SLAT's income is generally taxed to you under the grantor trust rules. This allows the trust to essentially grow free of income tax, thus leaving more for beneficiaries later. However, you must be prepared to pay those taxes even though you are generally receiving nothing from the trust (other than possibly installment payments).
While trusts offer numerous advantages, they incur upfront costs and often have ongoing administrative fees. The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional and your legal and tax professionals before implementing such strategies.
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges, as well as surrender charges and income tax implications if the policy is surrendered prematurely.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal professional.
LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial.
This article was prepared by Broadridge.
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