Broker Check

Keep Assets Out of An Estate, But Within Reach with a Spousal Lifetime Access Trust (SLAT)

May 25, 2023

Many advisors are finding that their clients are not alone in failing to create an estate plan. Only 34% of adults in the U.S. have an estate plan, according to an October 2022 survey by D.A. Davidson & Co.  In contrast, 37%, or the largest portion of survey respondents, said they didn’t have a plan at the ready, because they thought their estates were not large enough to need one. Moreover, 32% of the survey respondents said they had procrastinated and simply hadn’t gotten around to it. 

Time is no longer on the side of those who have not taken steps to plan for the future. In 2023, the top Federal estate tax rate is 40% with a $12.92 million per person gift and estate tax exemption.  The exemption amount is set to be cut approximately in half at the end of 2025, and it seems like Congress is unlikely to prevent this reduction. Those waiting until 2025 -- and even 2024 -- to initiate estate planning may be surprised when they’ll likely find out that all ofthe top tier trust and estate attorneys are completely booked by clients trying to meet the tax-sunset deadline. 

A major reason for procrastination about planning is the idea that assets transferred to an irrevocable trust will be out of reach and unable to be accessed by the donor or grantor. Fortunately, there are tools and techniques available today to mitigate this concern, as well as minimize the impact of both current estate tax policies and planned future changes to these policies. One such tool the team at Cedar Point Financial Services LLC finds increasingly popular is a spousal lifetime access trust (“SLAT”).  A SLAT is a relatively simple way for a married couple to meet wealth transfer objectives, while mitigating potential negative tax consequences and maintaining access to their assets. 

What is a SLAT? 

A SLAT is an irrevocable trust established by a grantor spouse for the benefit of the other spouse – called the beneficiary spouse – plus other family members, such as children and grandchildren. Each spouse gifts up to their maximum exemption amount to a SLAT, which is set up for the benefit of the other spouse and their children and/or grandchildren. The beneficiary spouse of each SLAT is granted limited access to the trust’s funds to meet his or her needs. 

For example, Edward, as a grantor, creates a trust for the benefit of his wife, Julie. He contributes $12.92 million (his 2023 maximum gift tax exemption) to the trust without any tax consequences.  Income from the trust is distributed to Julie under a HEMs (health, education, maintenance and support) provision and Julie can do whatever she chooses with this money.   

Julie does the same for Edward but is careful that the trust she establishes for her husband is not identical. If the trusts are identical, they could run afoul of the ‘reciprocal trust doctrine,’ resulting in negative tax implications. In addition, residents of community property states will first want to convert some of their community property into separately owned properties. Couples in other states may also need to transfer a variety of assets to one another so each spouse has an identifiable set of assets. 

At the death of the trust’s income beneficiary, the remaining beneficiaries – the children and/or grandchildren – begin to receive the trust benefits. 

The Key to a Successful SLAT:  Life Insurance 

A problem arises when either Edward or Julie dies, and the surviving spouse only has access to the assets in the trust for which they are an income beneficiary. In other words, the surviving spouse used to be able to access assets in the other trust via their spouse who was the income beneficiary. Now, the surviving spouse could be cut off from up to half of the assets transferred to their SLATs. 

A solution involving life insurance can replace this loss of access. Each SLAT should purchase a life insurance policy on the life of the other spouse. If Julie passes before Edward, Edward will continue to benefit from his SLAT and his SLAT will collect the life insurance death benefit proceeds to replace the values of Julie’s SLAT to which he no longer would he access since they will have gone to the children and/or grandchildren as the remaining income beneficiaries. 

Similarly, if Edward passes first, Julie will continue to have access to her SLAT and her SLAT will collect the life insurance death benefit proceeds on Edward’s life, replacing the access to the values of Edward’s SLAT.

Cedar Point Financial Services LLC works with clients and their advisors in determining if a SLAT is an appropriate estate planning strategy from which a client may realize these benefits: 

  • No gift taxes are incurred on amounts up to $12.92 million transferred to a SLAT in 2023.
  • Provides a spouse a lifetime interest in the income and principal – limited to his or her health, education, maintenance or support under a SLAT’s HEMs provision. 
  • Allows the beneficiary spouse of the SLAT to be the trustee of the trust. 
  • Taxes income to the SLAT back to the grantor’s spouse. 
  • Excludes taxes paid by the grantor from being characterized as taxable gifts to the SLAT. 
  • Excludes the total value of assets (including appreciation) in the SLAT of either spouse upon their death. 
  • Allows the beneficiary of the SLAT to do something similar for the benefit of the grantor of the SLAT. 

Another Option:  The “Reversible” SLAT 

In some instances, SLATs created by each spouse for the other may not be viable due to reciprocal trust doctrine concerns, an unmarried grantor, or perhaps additional lifetime planning flexibility for the grantor(s) is desired with the SLAT(s). A “Reversible” SLAT, also known as a Wealth Retirement and Asset Protection Trust (“WRAP”) or an Ultimate Irrevocable Life Insurance Trust, allows the grantor/insured himself or herself to have indirect access to the trust’s assets, including the cash value of a life insurance policy inside the trust. The trustee is given power to loan funds from the trust at any time, as long as the grantor substantiates the loan with a promissory note. The note should bear interest at the prevailing Federal rate and be secured by a pledge of the grantor’s assets.  

The grantor’s ability to borrow using secured promissory notes is similar to the right to reacquire trust corpus by substituting property of equal value in IRC § 675(4)(C) and Revenue Ruling 2008-22. 

Assuming the “Reversible” SLAT is income tax “defective,” meaning the grantor is treated as the owner of trust for income tax purposes, the payment of interest to the trust should not create interest income for the trust as the grantor and the trust are considered a single entity for income tax purposes. Therefore, any transactions between the two are disregarded for income tax purposes. (IRC §§ 671, 675, IRS Reg. 1.671-2(c), and Rev. Rul. 85-13). Interest that accrues or is paid in the year of the grantor’s death would be taxable to the trust due to the resulting termination of grantor trust status. 

The trustee can provide liquidity for the loan by taking tax-free policy loans against the life insurance policy owned by the trust. At the death of the grantor, the loan owed to the trust, which is a debt that reduces the taxable estate for Federal estate tax purposes, is repaid to the trust and the repaid loans, together with the death benefit proceeds, are all estate tax-free since they are owned by the trust. 

For example, assume a grantor with $10 million of assets dies while still owing $5 million to his trust. The $5 million owed to the trust reduces his taxable estate from $10 million to $5 million, potentially saving $2,000,000 in federal estate taxes (disregarding any remaining exemption for simplicity’s sake). To optimize the mitigation of estate taxes, the grantor generally should borrow to fund necessary expenses, rather than reinvesting the money inside his or her estate. 

The grantor cannot have unlimited borrowing power as this could lead to the collapse of the life insurance policy and infringe upon the rights of the trust’s beneficiaries. Great care must be taken to draft the trust and to properly arrange for the ability of the grantor to borrow from it. 

The planning specialists at Cedar Point Financial Services LLC find the trust strategy is especially useful for clients who are building wealth inside life insurance policies, which have not been transferred to an irrevocable trust.  Policies with cash values up to the Federal estate tax exemption amount may be transferred without gift-tax consequence to a trust, while preserving the ability to access the cash values.  In such a situation, the grantor-insured would need to live at least three years to avoid a “clawback” of the death benefit proceeds for estate tax purposes (IRC §§ 2042 and 2035). 

At present, there is no direct legal authority regarding the use of a “Reversible” SLAT, and a client’s legal and tax advisors should make decisions on an individual basis whether to include that language in a trust document, so the client’s future flexibility is maximized. 

Below is a diagram of how the strategy can work: 

It is Time to Act 

The window to take advantage of the record high gift tax exemption amount is closing. Even those who have estates under the current exemption amount may discover it difficult to engage with trust and estate attorneys for any level of planning after this year, because of the urgency created by clients who procrastinated about their exemptions, and are attempting to beat the December, 31, 2025 sunset deadline. At Cedar Point Financial Services LLC, we work with clients’ legal, accounting, and other advisory professionals in developing and implementing strategies that optimize their legacies to family and community.  A SLAT may be a solution to utilize the current, record-high gift tax exemption amount to reduce a taxable estate while still allowing access to transferred assets.