By Boyce F. Lowery, CLU, ChFC
“You can’t have your cake and eat it (too)” is a popular English idiomatic proverb or figure of speech. The proverb literally means ‘you cannot simultaneously retain your cake and eat it’. Once the cake is eaten, it is gone. It can be used to say that one cannot have two incompatible things.” (1) We beg to differ. Further, we believe one can give away his cake and keep it too. How?
When it comes to a married couple’s finances, there is a way to reduce one’s estate (taxes) through gifting while still keeping access to those funds in a manner of speaking. Given the uncertainty of today’s economic environment, potential income tax and estate tax increases and continued fallout from the COVID-19 pandemic, a married couple may now wish to take advantage of a special type of financial tool, namely a Spousal Lifetime Access Trust (SLAT). The SLAT offers a unique and flexible way to utilize the estate tax gift exemption, raised from $11.58 million in 2020 to $11.7 million in 2021 (2) while retaining rights to the assets gifted all while reducing the couple’s taxable estate.
Speculation abounds as to the possibility that the estate tax exemption will be reduced before it automatically sunsets in 2026, and the SLAT offers the advantage of protecting marital assets from potential estate taxes in the event of a rollback. Unlike other instruments, the SLAT allows one spouse (the donor spouse) to “have their cake and eat it too” by transferring assets to the other spouse (the beneficiary spouse) via an irrevocable trust in a way that allows both spouses to benefit from the funds during their lifetimes.
An often-quoted Judge who served some 52 years, Learned Hand, said it this way: “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes.” (3)
Principal Characteristics and Benefits of a SLAT
The chief advantage to a SLAT is the opportunity to protect marital assets against the estate tax; funds transferred to the trust account are excluded from both the donor spouse’s gross estate and the estate of the spouse for which the trust was created. There is no “claw-back” allowed by the IRS of assets transferred to a SLAT, which means that if Congress reduces the exemption limit in the future, the new limit will not be applied to assets that have already been transferred. Therefore, if you take advantage of a SLAT today, you are effectively sheltering all of the assets transferred to the SLAT from the estate tax regardless of any changes to the gift and/or estate tax exemption limit in the future. Also, should the assets appreciate after being transferred to a SLAT, the appreciation on the assets will also be excluded from the estate tax.
SLATs are funded with the donor spouse’s after-tax income and/or assets. The SLAT is a grantor trust. Thus, the income tax on any earnings from assets once in the trust are payable by the grantor, not the trust. Often, to avoid income taxes on growth of the SLAT assets, to provide for the opportunity of tax-free cash flow from the Trust to the Spouse and to leverage up the assets for the Spouse and heirs, a specially structured life insurance policy is purchased by the SLAT on the life of the donor spouse. Aside from providing a tax shelter, a SLAT can also shield marital assets from creditor claims.
Restrictions and Limitations of SLATs
Like any irrevocable trust, a SLAT’s terms generally cannot be altered or amended after the fact. Once a donor spouse transfers funds or assets to a SLAT, that donor spouse permanently loses access to the funds, but of course the spouse beneficiary still has access to those assets if needed, even though the funds are outside the estate of both the donor spouse and the spouse beneficiary while in the trust. Any asset or funds received by the spouse beneficiary from the trust should be consumed to avoid bringing the assets back into the taxable estate of the spouse beneficiary.
With careful planning and drafting, it is possible for the spouse beneficiary of the first SLAT to create a SLAT for the benefit of the donor spouse of the first SLAT. However, it is critical to avoid the reciprocal trust doctrine. Complications can also arise in the event of a divorce, and the advice of legal counsel is essential to ensure that appropriate provisions are included to factor in the major contingencies.
While all assets in a SLAT are protected against claims from the donor spouse’s creditors, the beneficiary spouse’s creditors may be able to exercise claims against part or all of the assets, depending on the structure and terms of the trust. Placing specific restrictions on the beneficiary spouse’s right to take distributions can strengthen protection from the beneficiary spouse’s creditors. In some cases, it is necessary to include an independent third-party trustee to oversee distributions.
We’re Here to Help
A SLAT is a powerful and flexible financial instrument that offers a multitude of options depending on your asset structure, objectives and strategy. In particular, right now is an advantageous time to think about setting up a SLAT, while the gift tax exemption limit remains high and the window of opportunity is still (barely) open. If you’re interested in learning more, give us a call at (888) 827-0146 to set up an initial conversation about how we can work together to make the most of your assets while avoiding unnecessary taxes.
Boyce Lowery is a 40-year veteran and established expert in the insurance industry. As the managing partner of Suncrest Advisors, he, his partner, and their associates all aim to provide financial security and peace of mind to business owners, executives and professionals, and high net-worth individuals across the United States. Along with more than four decades of experience, Boyce is a Chartered Life Underwriter® (the premier designation for insurance professionals signifying specialized knowledge in life insurance and estate planning) and a Chartered Financial Consultant® (known as the advanced financial planning designation). To learn more, visit https://suncrestadvisors.com/ or connect with Boyce on LinkedIn.