A crucial and sometimes overlooked part of your financial plan is estate planning. The complexity of your estate plan will be reflective of your financial situation. A comprehensive estate plan considers strategies to maximize the current tax exemptions. For high net worth couples, especially second marriages with assets held in individual ownership, a potentially impactful tax-saving opportunity is available now, a spousal lifetime access trust (SLAT).
A SLAT is an irrevocable trust that allows you to transfer assets from your taxable estate for estate tax planning purposes. The current historically high federal lifetime gift exemption of $12.92 million per individual (2023) is slated to decrease with the expiration of the TCJA provision, if not even sooner. By 2025 the limit will be reduced to $5 million, inflation-adjusted. Given the lifetime exemption is expected to decrease, now is the time to take advantage of the higher federal lifetime gift exemption. A comprehensive estate plan starts with the basics, wills, POAs, medical directives, etc. We consider your estate plan to be one of the top items to tackle on our list of ‘5 Must-Do Moves to Protect Your Family & Finances’. As your wealth, wishes, and complexity increase, trusts will likely play an integral role in your estate plan.
The tipping point at which a SLAT should be a part of the estate planning conversation is when your estate is worth more than $5 million. Between the $5 million and $12.92 million current limit, you have a unique opportunity to shield a portion of your estate before the reduction in 2025. Rules change all the time; however, in this case, the difference is not expected to be reversed or ‘clawed back’ by the IRS. The IRS even states as much in their Estate and Gift Tax FAQs. Today with the increased exemption of $12.92 million per individual, few have to worry about significant estate tax consequences. However, once the exemption is reduced with the sunsetting of TCJA, estate taxes will be a concern for many more individuals and couples.
A spousal lifetime access trust (SLAT) is not the only trust that solves taxation woes in estate planning. For instance, a marital trust is also designed to minimize estate taxes, but it funded at the first spouse’s death. The estate taxes are essentially postponed until the second spouse’s death by using the marital deduction. However, a SLAT is funded and accessible much earlier as the gift to fund the trust takes place while both spouses are living. As the funding spouse, you can begin to see the impact while you are still around.
Timing is everything
Timing is essential for two reasons. Firstly, time is of the essence to maximize your exemption with the historically high limit. Secondly, if you and your spouse both plan to create and fund SLATs, you must be very careful. You and your spouse must not create identical trusts. If you create two trusts that are too similar, you run the risk of violating the ‘reciprocal trust doctrine.’ Violating the doctrine will make all the work of creating the trusts null and void. Once the IRS deems that you have violated the doctrine, the IRS, in other words, is viewing the trusts as so similar that they cancel each other. Your attorney will guide you on the proper timing of creating two trusts and ensuring they are uniquely designed in purpose, creation date, and possibly even the creation state.
A SLAT is a strategy that you can implement now to prepare for the expected decrease in the exemption. If you are going to explore the implications of if you should include a SLAT in your estate plan, there are several key steps and key players to include in the conversation. Your attorney and financial planner will be critical players in a thorough analysis. Once an analysis indicates a SLAT would be an appropriate fit, the ultimate creation should be completed before the decrease in the exemption so that you can take advantage of today’s higher exemption. Since tax regulations can and have changed at any time, obviously, this is not something to wait on.
No changing your mind
A SLAT works by moving assets that you aren’t planning to use in your lifetime into an irrevocable trust. The irrevocable nature of the trust requires you complete thorough due diligence on this strategy; once you place the funds in the trust, you cannot reverse your decision. The trust is funded by gifting these assets from one spouse for the benefit of the other spouse, typically with children or grandchildren as the beneficiary. The spouse completing the gifting is the spouse using their exemption. The gift removes the assets from the taxable estate to grow and build wealth for future generations. High net worth couples, especially those with assets held in individual ownership, such as in second marriages, could use a SLAT not only for tax planning but to dictate their wishes for the assets including who will benefit. If your financial plan indicates you, as the spouse completing the gifting, will need to access these funds, you should evaluate other options that would better suit your income needs.
Of course, you may indirectly benefit if your spouse takes distributions from the SLAT. Still, the distributions cannot be directly for your benefit as the gifting spouse. The distributions must be clearly delineated, such as going into an individual account in your spouse’s name rather than a joint account. The strict nature of the irrevocability of the strategy can complicate a relationship that is unsteady. If divorce is even a minor thought, a SLAT probably is only going to muddy the waters. As the gifting spouse, you are giving up your ownership and ultimately control of the assets to the SLAT. Should your spouse pre-decease you, the SLAT is then passed to the beneficiaries.
Consider all the consequences
There are a wide variety of assets that can be used to fund the SLAT. However, the assets must be owned by the spouse creating the SLAT; they cannot be owned as JTWROS or any other type of joint ownership. The potential downside for future generations’ tax planning is that once the assets fund the SLAT, they lose the ability for a step-up in basis at the death of the owner.
Ultimately, if your estate plan warrants it, a SLAT could bring tremendous value and savings by removing the gifted assets from your taxable estate. The future appreciation of those gifted assets is also removed from your taxable estate. A SLAT is a potential solution to a unique time in estate planning history. Given the expectations for the tax law changes in 2025, together with your financial planner, you should thoroughly evaluate the entire strategy before implementation.
If you know someone who may benefit from discussing how their estate plan fits into their broader financial plan, please encourage them to reach out.