For most Americans, estate taxes are a non-issue. Under current tax law, the first $12.06 million of an individual’s estate is excluded from the tax in 2022 (it was $11.7 million in 2021). A married couple, therefore, could leave an estate worth up to $24.12 million in 2022 without being subject to estate tax.
But estate taxes are a perennial political football, and the goalposts can move. The current estate tax regime, in fact, is temporary and set to expire on December 31, 2025. Starting in 2026, unless new legislation is passed, the lifetime estate tax exclusion with expected adjustments for inflation will drop to about $6.2 million per person. As a result, many people who may not have an estate tax problem today may become subject to taxation at a 40 percent rate unless the law is changed.
Whether you already have an estate tax issue or are simply concerned about the rules changing in the future, one option for married couples concerned about the possibility of estate taxes is to transfer assets to an irrevocable trust.
“Historically, to best ensure escape from estate taxes, irrevocable trusts were designed to make no distributions to beneficiaries until after the death of the spouse who transferred assets into the trust, or sometimes until after the death of both spouses,” says Dan Finn, senior director of Advanced Planning at Northwestern Mutual.
“But some families are reluctant to relinquish complete control of assets until one or both members of a married couple pass away, just in case circumstances change in the future,” Finn says. “For example, their fortunes might take a turn for the worse and they might find they could use the assets that they had ‘locked away’ in the irrevocable trust. Or, as unlikely as it may seem, future law changes might eliminate the estate tax altogether, making it unnecessary to keep assets in the trust.”
An answer for those who want to remove assets from their taxable estates, but want to maintain some ability to enjoy the assets before death, is to use an estate planning tool known as a SLAT, or Spousal Lifetime Access Trust.
What is a spousal lifetime access trust (SLAT)?
A SLAT is an irrevocable trust, which means it generally can’t be changed once created. It enables one spouse to make a gift that can benefit the other spouse even while the spouse who made the gift is still alive. In 2022, the lifetime gift-tax exclusion — or how much an individual can give in gifts over his or her life without paying a gift tax — is $12.06 million. Gifting assets to a SLAT removes those assets from a couple’s combined estate.
How a spousal lifetime access trust works
Without getting too deep in the legal weeds, here’s how a SLAT works: One spouse, known as the grantor or donor, creates the trust. He or she then gifts property to the trust for the benefit of the other spouse, known as the non-grantor or non-donor spouse. The donor usually also includes other family members, typically children and grandchildren, as beneficiaries of the SLAT. The non-donor spouse might be the sole beneficiary of the trust while alive, with the children or grandchildren becoming beneficiaries only after his or her death, or the non-donor spouse and everyone else may be beneficiaries at the same time.
A SLAT can be funded with a variety of assets (cash, securities and life insurance, for instance) but it is important that only assets owned by the donor spouse individually — not those owned jointly by the couple — be gifted. Using property owned by both spouses would negate the benefits of the SLAT.
Advantages of a SLAT
One key advantage of a SLAT, in addition to reducing an estate’s assets, is that it permits the non-donor spouse to request distributions of income or principal, if needed, to maintain the couple’s normal standard of living.
Residents of states that impose their own estate tax also may benefit from having a SLAT even if they do not expect to be subject to federal estate tax, because the trust will remove assets that could be subject to a state tax.
Finally, if a SLAT is a so-called “grantor trust,” which is typically the way a SLAT is structured, another benefit is that the trust will not owe any income tax. Instead, while the donor spouse is living, he or she is responsible for any tax on the income the trust earns. That allows assets inside the trust to grow without being reduced by income tax.
Possible drawbacks of a SLAT
One disadvantage of a SLAT is that if the non-donor spouse dies before the donor, the donor spouse loses indirect access to trust assets. Nonetheless, the trust assets can continue to benefit the donor's children and other family members, either by remaining in trust for their benefit or being distributed to them outright.
Another potential negative involves divorce. Aware of that possibility, estate attorneys drawing up a SLAT typically mitigate the risk by including language that terminates the non-donor spouse's beneficial interest in the trust in the event of divorce.
Also, while the non-donor spouse can serve as the SLAT’s trustee and authorize distributions to themselves, those distributions must be limited. Distributions beyond what are considered reasonable to cover costs related to health, education, maintenance or support would generally cause trust assets to be included in the taxable estate of the non-donor spouse. If the non-donor spouse does not serve as trustee, distributions to the non-donor spouse can normally be more generous without causing estate inclusion.
What’s more, to prepare for unforeseen changes in estate tax law or the couple’s circumstances, the trust might even be drafted to permit the SLAT provisions to be removed in the future, if need be. One way to do this is to perhaps include a “trust protector” in the trust, who could be empowered to make such changes.
Is a Spousal Lifetime Access Trust Right for You?
A SLAT may be a useful tool for a couple that wants to avoid estate taxes by giving assets to an irrevocable trust, but are not ready to completely remove the ability of both spouses to enjoy those assets. If you have questions, reach out to your financial advisor and estate planning attorney.
This publication is not intended as legal or tax advice. Consult with a tax professional for tax advice that is specific to your situation.