Recent News:  Spousal Lifetime Access Trusts

Spousal Lifetime Access Trusts

By:
Michael J. Parise, Esq.
Advanced Planning
1223 N. Church Street
Moorestown, NJ 08057
P: (856) 988-8300
F: (856) 988-8319
www.copperbeechfg.com
 

 

Irrevocable trusts are a cornerstone planning tool for high net worth families looking to lower their estate tax exposure.  When structured properly, assets owned inside these trusts are not included in the family’s gross estate, sometimes forever.  However, grantors of irrevocable trusts are often reluctant to make transfers since gifts to such trusts cannot be undone, and the trusts themselves are typically out of their control/benefit once transferred.  These families are then faced with a conundrum.  They must weigh the benefits of reducing their estate tax exposure and increasing asset protection against the negative of transferring assets they may need in the future. 

 

Fortunately for families, there is an alternative that may help solve this dilemma: the spousal lifetime access trust (SLAT).  A SLAT is an irrevocable trust that one spouse creates for the other.  One spouse becomes the lifetime beneficiary of the trust, often with their descendants as remainder beneficiaries of the trust after both spouses pass away.  As the lifetime beneficiary of the trust, qualified distributions made to the spousal beneficiary can then be used to benefit both spouses, as needed.  As such, a grantor of a SLAT can transfer assets to this trust and still retain indirect access to them through his/her spouse.  If the trust language is written carefully by the drafting attorney, assets owned by the SLAT should also not be included in the gross estates of either spouse and should be adequately protected from the claims of any future creditors.  SLATs are therefore a great tool to utilize with families that have a need to lower their gross estates but may be reluctant to transfer assets they may need in the future.

 

Requirements

 

Care should be taken in both the drafting and ongoing administration of a SLAT.  Because one spouse can be both the trustee and beneficiary of the trust, any distributions that she makes to herself must be limited to a health, education, maintenance, or support standard to avoid the trust’s assets being included in the spouse’s gross estate.  While these terms can be interpreted flexibly, it does limit the spouse’s ability to make distributions to him/herself.  To combat this, the trust could give the spousal beneficiary the right to unilaterally withdraw the greater of $5,000 or 5% of the trust principal on an annual basis without violating any of the asset protection or estate reduction benefits.  Another common technique that adds flexibility in SLAT administration is to appoint an independent entity as a co-trustee.  The key word here is “independent”.  The Internal Revenue Code defines this as a truly independent 3rd party that has no beneficial interest in the trust.  It cannot be an immediate family member or employee, but could include a 3rd party trust company or close family friend or advisor.  If a qualified independent trustee is chosen, that person could have the authority to distribute assets to the beneficiary spouse for any reason whatsoever, if such trustee is given full and absolute discretion on that decision.  This additional flexibility gives the spousal beneficiary the potential ability to a greater access to the trust’s assets.

 

Considerations

 

There are potential pitfalls to successfully implementing a SLAT that families and their advisors should guard against: 

 

  • Careful Administration – Tax law will include in a decedent’s gross estate any property that the decedent had “incidents of ownership” over.  Therefore, the family must make sure that only the trustee/beneficiary control the SLAT’s assets and not the grantor. 
  • Premature Death - If the trustee/beneficiary spouse passes away prematurely, the grantor spouse that created the trust will no longer have indirect access to the trust’s assets.  Were this to occur, the descendants of the spouses would then become beneficiaries of the trust. 
  • Divorce – Along similar lines, if the spouses were to divorce, complications in administering the trust would arise.  Careful drafting should include language that states in the event a divorce were to occur, the ex-spouse is removed as a beneficiary with the descendants replacing him/her.  Language can also be included that in the event the grantor was to remarry, that new spouse can slide into the beneficiary role.
  • Separate Property Gifted – It is vital that all property contributed to the trust be considered the separate property of the Grantor.  Assets that are jointly owned cannot be contributed to a SLAT without eliminating the estate reduction and asset protection benefits.  Furthermore, if you reside in a community property state, care must be given in how assets are added to the trust.  In community property states, assets acquired during the marriage are presumptively owned 50/50 between spouses regardless of the actual titling of the asset.  Unless a property separation agreement is entered into prior to a contribution to a SLAT, 50% of any contribution could be considered as being made by the trustee/beneficiary spouse.  Such a result would also eliminate any asset protection and estate reduction benefits of the strategy.
  • Gift splitting -  When reporting any gifts made to a SLAT, ensure that the gift tax return preparer does not elect gift splitting.  Gift splitting states that any property gifted to the trust will presumed to be made equally by both spouses regardless of whether the property is considered separate property of the grantor.  As just stated, such a result will eliminate the tax and asset protection benefits of the strategy.
  • Avoid reciprocal SLATs – A clever reader may be wondering whether a second SLAT can be created to benefit the spouse who is the creator of the first SLAT.  Since the grantor of the first SLAT doesn’t have direct access to first trust, creating a second SLAT solves this problem by making him/her the lifetime beneficiary of the second SLAT.  While this can be accomplished, it but must be dealt with very carefully.  If the two trusts are considered “substantially similar” to each other, the IRS will ignore both trusts and include the assets of both trusts in the spouses’ gross estate.  While there are no definite laws to follow, court cases have given drafters guidelines to adopt that include:
    • Executing the trusts at different times.
    • Not placing fractional interests of the same assets in each trust. 
    • Different distribution language in each trust.
    • Include a limited power of appointment in one trust but not the other.
    • Use different trustees.

 

Conclusion

 

Though they may result in increased complexity in an estate plan, SLATs can be a flexible and effective way for high net worth families to remove assets from their taxable estate, protect the assets from creditors, and still retain limited access to them.  This can alleviate the concerns that many families have with implementing advanced estate transfer planning in their generational wealth plan.  If you are interested in how spousal lifetime access trusts could benefit your generational wealth plan, please contact us. 

 

 

 

Securities offered through American Portfolios Financial Services, Inc. Member FINRA/SIPC.

 

Investment advisory and financial planning services offered through American Portfolios Advisors, Inc., an SEC Registered Investment Advisor. Copper Beech Financial Group, LLC is an unaffiliated entity of American Portfolios Financial Services, Inc. and American Portfolios Advisors, Inc.  Investments in private business enterprises represent significant risk and there are no assurances of future performance or results.  Neither Copper Beech, APFS, nor its representatives provide tax, legal, or accounting advice.  Please consult your own tax advisor before making any decisions regarding tax or legal issues.