Spousal lifetime access trusts
By Julius Giarmarco
Giarmarco, Mullins & Horton, P.C.
Spousal lifetime access trusts will be particularly attractive to many high-net-worth clients looking to maximize their $5 million gift tax exemptions.
While many high-net-worth married couples may like to take advantage of their $5 million gift tax exemptions, they may be reluctant to do so because they lose access to the gifted property’s income and principal.
One strategy to keep the income and principal within the reach of the donor is a spousal lifetime access trust (SLAT). In simple terms, a SLAT is an irrevocable trust set up by one spouse for the benefit of the other spouse.
For example, assume a husband creates a SLAT for the benefit of his wife and funds it with his $5 million gift tax exemption. During the wife’s lifetime, the trustee (which may be the wife) can distribute to the wife income and principal as needed for her health, education, maintenance and support. The wife can also be given the power to withdraw the greater of $5,000 or 5 percent of the trust principal annually, and a testamentary limited power of appointment to “rewrite” the trust provisions upon her death.
Thus, the husband has indirect access to the trust’s income and principal. When the wife passes away, the unappointed trust property (including the appreciation thereon) passes — estate tax free — to the children (and possibly even more remote descendants depending on state law).
An added benefit of a SLAT is that it protects the beneficiaries from creditors, including ex-spouses.
Finally, a SLAT would likely be a grantor trust as to the donee spouse, unless the consent of an adverse party were required for distributions to the spouse. Thus, the SLAT’s assets compound free of income taxes.
One obvious problem with the above factual situation is that upon the wife’s death, the husband loses his indirect access to the trust’s income and principal. One simple solution to this problem is for the wife to create an irrevocable life insurance trust for the benefit of her husband.
The ILIT would be funded with a life insurance policy on the wife’s life to replace the wealth lost to the husband in the SLAT (in the event he survives his wife). If necessary, the SLAT can loan the ILIT the funds needed to pay premiums under a split-dollar arrangement. Can a married couple both create SLATs and ILITs for the benefit of each other so as to increase the gift to $10 million?
It’s possible, but the IRS could look through the transactions and apply the reciprocal trust doctrine. That doctrine assumes that each spouse established a trust for his/her own benefit, thus resulting in estate inclusion for each spouse of the trust property.
Accordingly, the trusts must be drafted differently. For example, different trustees for each trust could be used; the beneficial interests could be made dissimilar by giving one spouse a 5 percent annual withdrawal power and the right to income but not principal, and the other spouse no 5 percent annual withdrawal power nor the right to income, but the right to principal; the trusts could be created at different times; and one spouse could be given a testamentary limited power of appointment but not the other.
SLATs, like many other estate planning techniques, have some drawbacks. Access to trust assets is available only to the grantor’s spouse (and/or other beneficiaries) — not to the grantor. Thus, the grantor only has indirect access to the trust property through his/her spouse. Therefore, divorce or the death of the spouse will eliminate this limited access.
But as mentioned above, by having the beneficiary-spouse establish an ILIT for the benefit of the grantor-spouse, the wealth lost to the grantor in the SLAT can be replaced by the ILIT. And the SLAT must be carefully drafted to avoid inadvertent estate tax inclusion — particularly if reciprocal SLATs are established. However, SLATs will be particularly attractive to many high-net-worth clients looking to maximize their $5 million gift tax exemptions.
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