Leveraging Spousal Lifetime Access Trusts (SLATs) in Your Estate Planning

Estate planning is a critical aspect of securing your family’s financial future. This blog post will provide a comprehensive breakdown of estate planning, with a specific focus on the differentiation between revocable and irrevocable trusts. Lastly, we delve deeply into the benefits of Spousal Lifetime Access Trusts (SLATs), an irrevocable trust designed for married couples.

Estate Tax

Understanding the Federal Estate Tax

The federal estate tax is a 40% tax imposed by the U.S. federal government on the transfer of assets and property upon death. It is levied on the total value of your gross estate, which typically includes all the assets and property you own or have an interest in at the time of your death, such as real estate, personal property, bank accounts, investment accounts, retirement accounts, and life insurance death benefit proceeds.

Generally federal estate tax does come into play unless you pass away with a gross estate, plus lifetime taxable gifts, over $12.92M (if single) or $25.84M (if married). As of writing (2023), the current estate tax exemption amount is $12.92M per person, and married couples may share exemptions by electing portability, which doubles this limit to $25.84M.

This means that individuals / married couples can transfer up to $12.92M / $25.84M during life or at death, without incurring the 40% federal estate tax.

Impending Changes

The exemption amount is currently at its highest point in history, and it is important to note that this can and most likely will change under future tax law. The current estate tax exemption is set to sunset at the end of 2025, which will effectively reduce the exemption amount by half.

State Tax Considerations

In addition to federal estate tax, considerations should also be made for state death taxes. As of 2023, twelve states and the District of Columbia impose estate taxes, and six impose state inheritance taxes. This ranges anywhere from 0 – 20% depending on your state of residence.

Trust Planning (Revocable vs. Irrevocable Trusts)

Revocable Trusts

A revocable trust, also known as a “revocable living trust” is a legal document that you create during your lifetime to manage and distribute your assets at your passing. It is called “revocable” because, as the grantor (the person creating the trust), you retain the ability to make changes to, amend, or even revoke the trust entirely while you are still alive and of sound mind.

Assets held in revocable trusts do not avoid federal estate tax or state death tax.

Instead, they are primarily used for:

• Avoidance of Probate: One of the primary benefits of a revocable trust is that it allows your assets to pass to your beneficiaries without going through the probate process. Probate can be time-consuming, expensive, and public, while a revocable trust enables a smoother, private, and more efficient asset transfer after your passing.
• Privacy: Unlike a will, which becomes a public document during probate, the terms and assets of a revocable trust remain private. This confidentiality can be appealing to those who prefer to keep their financial affairs out of the public eye.
• Incapacity Planning: A revocable trust can also provide for the management of your assets in case you become incapacitated or unable to manage your financial affairs. The successor trustee you designate can step in to manage the trust assets on your behalf.
• Asset Management: You can appoint yourself as the initial trustee of the revocable trust, allowing you to continue managing your assets as you did before creating the trust. Upon your passing, the successor trustee you appointed will manage the trust assets and distribute them according to your instructions outlined in the trust document.
• Avoiding Ancillary Probate: If you real own property in multiple states, a revocable trust can help avoid the need for ancillary probate proceedings in each state where you hold property. This can save time and expense for your heirs.
• Control: Specific language can be written into the trust document to ensure distributions are carried out according to your wishes. In addition, you can include a bloodline protection provision, which would keep the assets in your family’s name in the event of a divorce.

Irrevocable Trusts

An irrevocable trust is a type of trust that, once established, generally cannot be modified, amended, or revoked by the grantor (the person who creates the trust). Once the assets are transferred into an irrevocable trust, they are no longer considered the property of the grantor, and control over those assets is transferred to the trustee (the person or entity responsible for managing the trust) and the trust’s beneficiaries.

Assets held in irrevocable trusts do avoid federal estate tax because they were taxable gifts at the time of transfer. For state death tax, some states require you to live a certain period of time after transfer for the assets to escape the death tax.

Irrevocable trusts are primarily used for the following:

• Estate Tax Reduction: One of the primary purposes of irrevocable trusts is to reduce the taxable estate of the grantor for federal estate tax purposes. Since the assets placed in the trust are no longer considered part of the grantor’s estate, they are not subject to estate taxes upon the grantor’s passing. This includes all growth on the assets after transfer.
• Asset Protection: Irrevocable trusts can provide a degree of asset protection, shielding the trust assets from potential creditors or legal claims against the grantor and the trust beneficiaries. However, the level of protection may vary depending on state laws and the specific terms of the trust.

• In addition, irrevocable trusts are also used for avoidance of probate, privacy, and control (as listed above under revocable trusts).

It’s important to note that once assets are placed into an irrevocable trust, the grantor generally relinquishes direct control over those assets. The trustee becomes responsible for managing the trust according to the trust document’s terms.

Spousal Lifetime Access Trusts (SLATs)

A Spousal Lifetime Access Trust (SLAT) is a type of irrevocable trust designed for married couples. SLATs are used in estate planning to leverage the benefits of irrevocable trusts while allowing one spouse (the donor spouse) to provide for the other spouse (the beneficiary spouse). SLATs can be a powerful tool for minimizing estate taxes and preserving family wealth, all while maintaining an element of control via the beneficiary spouse.

Structure of a SLAT:

1. Donor Spouse: One spouse (the donor spouse) establishes and funds the SLAT with the donor’s separate assets. Once the assets are transferred into the trust, they are generally no longer considered part of the donor spouse’s taxable estate.
2. Beneficiary Spouse: The other spouse (the beneficiary spouse) is the primary beneficiary and sole trustee of the trust. This means that the beneficiary spouse can receive income and principal distributions from the trust for their health, education, maintenance, and support. Plus, the assets still not taxed in the beneficiary spouse’s estate.
3. Additional Beneficiaries: In addition to the beneficiary spouse, SLATs often allow for other beneficiaries, typically the couple’s children or descendants. This allows for the wealth to be preserved and passed down to future generations.

Benefits of SLATs:

1. Estate Tax Reduction: By transferring assets into a SLAT, the couple can effectively remove those assets (and the appreciation) from their taxable estates.
2. Retained Access: Despite being an irrevocable trust, the beneficiary spouse can receive distributions from the trust for their benefit, which provides financial security while still achieving estate tax savings.
3. Gift Tax Efficiency: Utilizing the donor spouse’s lifetime gift tax exemption, assets can be gifted into the SLAT without incurring gift taxes, up to the donor spouse’s available exemption amount. This can be particularly useful for reducing the taxable estate over time.
4. Protection from Creditors: Assets in a SLAT are typically protected from the beneficiary spouse’s creditors, which can provide an added layer of asset protection.

Considerations for SLAT planning:

When setting up a Spousal Lifetime Access Trust (SLAT), several important considerations should be taken into account. Firstly, it’s vital to understand that the irrevocable nature of the trust means that once assets are placed into it, the donor spouse forfeits direct control over those assets. Additionally, SLATs are subject to specific tax rules and regulations, necessitating compliance to achieve the intended tax benefits. Lastly, the strength and trust of the spousal relationship plays a pivotal role, as the beneficiary spouse’s needs and financial security must be considered when determining distributions from the trust.