FLEXIBILITY IN UNCERTAIN TIMES-EXPLAINING THE SPOUSAL LIFETIME ACCESS TRUST TO CLIENTS

A Spousal Lifetime Access Trust (“SLAT”) is a trust established by one person that is held for the benefit of his or her spouse in a manner that will not be subject to the creditor claims of the spouse and other beneficiaries of the trust and also will not be subject to federal estate tax in the estates of such beneficiaries.  The SLAT has its roots under the common law of all 50 states of the United States, and has been fine-tuned and augmented by creative planners over the years to comply with and take advantage of guidance set forth under applicable state statutes.  Given the present uncertainty and possible changes with respect to the federal estate and gift tax laws, the SLAT offers clients flexibility while making use of what might be a vanishing lifetime gifting exclusion.

Under the federal estate and gift tax system, there is presently an $11,700,000 unified estate and gift tax exclusion amount.  This allows a person to make large gifts which reduce the exclusion amount for both estate and gift tax purposes without paying gift tax unless or until the entire exclusion amount is exhausted.  Current law provides for the unified estate and gift tax exclusion amount to be reduced to $5,000,000, plus increases for inflation as a result of the changes to the “Chained Consumer Price Index” since 2012 (which many estimate to be approximately $6,500,000) effective January 1, 2026.

There has been much discussion and ink spilled regarding the possibility of decreases to the federal estate and gift tax exclusion amounts prior to 2026.  Most notably is Bernie Sanders’ recently proposed “For The 99.5% Act,” which calls for a reduction in the estate tax exclusion amount to $3,500,000 and a reduction to the lifetime gifting exclusion amount to $1,000,000.  Under this Bill, any gifts made by an individual exceeding $1,000,000 would result in a gift tax that would be based upon graduated rates beginning at 45% and increasing up to 65%, depending on the amount of the gift.  Therefore, many wealthy clients are faced with the prospect of a vanishing exclusion amount, which has caused them to consider making gifts of assets to utilize an increased gifting exclusion amount that may not be available in the near future.  Nevertheless, while many clients recognize that they want to use their vanishing lifetime gifting exclusion, they may not be inclined to part with the dominion, control, and access to assets that would otherwise be used for gifting purposes.  

For married couples, the SLAT is an excellent tool to help achieve the balance between gifting assets to make use of lifetime gifting exclusion and retaining the possibility of assets to such assets because it involves one spouse establishing a trust for the other spouse whereby the beneficiary spouse can receive distributions as needed for his or her health, education, maintenance, or support (“HEMS”).  The other spouse also can be the sole trustee or a co-trustee of the SLAT, and the assets of the SLAT should not be subject to the beneficiary/spouse’s creditors or subject to estate tax in the beneficiary/spouse’s estate.

This is based upon the federal estate tax law in this area, which was enacted to run parallel to a fundamental tenet of the common law with respect to “third-party irrevocable trusts.”   If a “third-party irrevocable trust” is formed by one person for the benefit of another person who can only demand or effectuate withdrawals to the extent needed for HEMS, the assets of the trust will not be subject to federal estate tax in the estate of the beneficiary (which typically would not be subject to the creditors of the beneficiary), unless there are certain strings attached or arrangement in place.

It is very important that a beneficiary of a trust (such as the beneficiary/spouse) not have the right or power to demand payment or distribution what is needed for his or her HEMS (such as distributions determined to be for the best interest of the beneficiary).  A trustee other than the beneficiary may have the power to distribute the assets of the trust to the beneficiary beyond what is needed for HEMS, and this will not cause the assets of the trust to be subject to federal estate tax in the beneficiary’s estate or subject to the beneficiary’s creditors, so long as there is not an understanding between the beneficiary and the trustee that the trustee will make such distributions in excess of what is needed for HEMS.

As with much of the tax law and estate planning techniques, it can be a challenge to explain complex topics such as the federal estate and gift tax law and the SLAT to the clients in an easily understandable format that allows them to make an informed decision in view of the salient benefits and limitations.  It is the authors’ experience that even sophisticated and business-savvy clients can have difficulty with abstract concepts if they are not explained in layman’s terms in writing and in a format that can be referenced at a later time.  Clients can be better educated and have many of their questions answered by a well-drafted letter explaining the mechanics of a SLAT, the planning opportunities associated therewith, and the implications and limitations of the technique.  Such a letter can be invaluable in communicating the complex ideas associated with the federal estate and gift tax law and the SLAT in simple terms.

The authors recently prepared such a letter to a sophisticated retired CPA client that was largely similar to the following, although without the authors’ annotations in the footnotes, which provide considerations regarding the design of a SLAT to reader of this article…