Tag Archives: Trust Fundamentals

Key Considerations When Creating a Spousal Lifetime Access Trust

When setting up a Spousal Lifetime Access Trust (SLAT) as a part of an estate plan, there are several considerations to keep in mind, such as who the beneficiaries will be, how the trust will be funded, and avoiding reciprocal trust doctrines.

Naming Trustees

The grantor should not serve as trustee. A beneficiary spouse may serve as trustee but would be limited to making distributions to themself under an “ascertainable standard.” An Ascertainable Standard, or “HEMS” allows for distributions to be made for beneficiary needs related to health, education, maintenance, and support.

 

Naming Beneficiaries

The primary beneficiary is generally the spouse of the grantor; however, siblings, children, grandchildren, and other descendants may also be named as current or remainder beneficiaries.

 

Naming Trust Protector(s)

Another important consideration is naming a trust protector. While not a fiduciary position, a trusted friend, advisor, institution, or partnership may be assigned as trust protector and given the power to remove a trustee, as well as other duties in the trust agreement. The trust protector may also be responsible for appointing a new trustee if there are none currently acting, or further appointed in the trust document. Often, it is most advantageous to have a non-beneficiary hold this position due to tax considerations and conflicting personal interests in the trust.

 

Funding the Trust

A SLAT can be funded with a variety of assets; however, it is very important to maintain separate property between the grantor and beneficiary spouse. If the trust is funded with a jointly owned asset, there is a risk that the beneficiary spouse could be perceived as making a gift to the SLAT, which may result in the trust assets being includable in his or her estate, thus wasting the gifting exemption allocated by the grantor.

 

Drafting Flexibility

SLATs offer the opportunity to take advantage of one’s gift and estate tax exemption while maintaining indirect access to those assets through their spouse. Additional flexibility can also be given to the beneficiary spouse through a limited power of appointment. Other provisions to ensure future flexibility can be included such as expressly allowing for decanting and giving additional powers to a trust protector.

 

Avoiding Reciprocal Trust Doctrines

In situations where both spouses may be using a SLAT as part of their overall planning, there needs to be distinct differences in terms between the trusts of each spouse. If the trusts are too much alike, there is a risk of the IRS viewing them as a tax-avoidance strategy which would eliminate the positive estate planning tax impact.

 

Marital Considerations

A SLAT may not be a good idea in difficult marriages. One of the biggest advantages of a SLAT is that the grantor is able to continue enjoying access to the trust assets through the spouse. In the case of a divorce, this benefit is eliminated. To provide some protection for the possibility of divorce, SLATs can be drafted to eliminate a spousal beneficiary in the event of divorce.

 

State Income Tax

Because a SLAT is a “grantor trust” this means that income earned in the trust is taxed to the grantor. If the grantor is a resident of a state with a state income tax, the grantor will be required to pay state income tax on any income earned by the trust. If income tax planning is a primary purpose of the trust, or the trust holds assets earning a considerable amount of income, other structures such as a domestic asset protection trust (DAPT) or an incomplete non grantor Trust or “ING trust” may better achieve planning goals.

Benefits of a Spousal Lifetime Access Trust (SLAT)

One trust that married couples should consider when creating an estate plan is a Spousal Lifetime Access Trust (SLAT). A SLAT is an irrevocable trust created by one spouse for the benefit of the other spouse. There are several reasons to consider a SLAT as an estate planning strategy.

Use Estate and Gift Tax Exemptions

The current estate, gift and generation skipping transfer tax (GST) exemption is a historical all-time high of over $11 million per person. Whether a grantor’s estate is larger than that or much lower, it may make sense to take advantage of as much of the exemption as possible before the current exemptions sunset in 2025 or are changed. As with most irrevocable trusts, completed gifts using the exemption along with any future appreciation are sheltered from future estate and gift taxes.

 

Reduce or Eliminate Capital Gains Tax

SLATs may help reduce capital gains tax at the time of the grantor’s death. Under current law, if the trust holds appreciated assets, the grantor (or the spouse under Section 1041) could swap (or buy) the appreciated assets out of the trust and into the grantor’s name before death by transferring assets to the trust (typically cash) of an equal value. This is an estate tax neutral transaction since the same value remains in both the trust and grantor's estate. However, the appreciated assets in the hands of the grantor (or spouse) and therefore the grantor or spouse’s estate, will qualify for a step-up in basis at death, thus eliminating the unrealized appreciation or gain. If the estate tax is repealed, it could be replaced by a capital gains tax at death.

Further, a capital gains tax may be implemented for gifts of appreciated assets. Assets transferred to a SLAT before such a change may avoid any capital gains tax by gift. At death, the same swap or substitution power used above can be applied in the opposite manner as a reverse swap. If the grantor has appreciated assets in his or her estate prior to death, the grantor may be able to swap them into the SLAT prior to death and avoid a capital gains tax on death. Under either scenario, it is possible that the SLAT may provide an income tax planning opportunity.

 

Get Creditor Protection

As an irrevocable trust, SLATs can provide meaningful asset protection from future potential claims of creditors (i.e., protect assets in trust from malpractice claims, beneficiaries’ divorcing spouses and other suits). This protection applies to assets transferred to the trust if not characterized as a fraudulent conveyance. When a SLAT serves as an Irrevocable Life Insurance Trust (ILIT), policy cash values during the insured's life and death benefit proceeds are also protected.

 

Take Advantage of Grantor Income Tax Ratex

Because SLATs are a “grantor trust” this means that they are taxed to the grantor of the trust. This means that any trust earnings (i.e., dividends, interests, capital gains) are accounted for on the grantor’s personal return. This allows the trust the potential to grow “tax-free” as far as the beneficiaries are concerned, because the grantor is paying the tax bill.

It is often advantageous for trusts to be taxed at an individual level, rather than at the trust level, as the tax brackets for trusts are compressed compared to individual tax brackets for 2022 – a trust will hit the top tax rate of 37% after $13,450 of income, whereas an individual doesn’t reach the top tax rate until they exceed well over $500,000 of income. Another benefit is that the payment of those taxes by the grantor is not considered an additional gift.

Important Considerations for Making Irrevocable Life Insurance Trusts Work

When setting up an irrevocable life insurance trust (ILIT) as a part of an estate plan, there are several important factors to keep in mind, such as how the trust will be structured to avoid unnecessary gift tax, where the trust will have “situs” or be located, and who will be appointed as the trustee to make sure that the plan is carried out as the grantor intended.

Avoiding Gift Tax
Because contributions to an ILIT are considered gifts to the beneficiaries of the trust, an insurance trust must be properly drafted and appropriately administered by the trustee to avoid gift tax consequences. If an insurance trust is unfunded, the grantor will have to make regular contributions to the trust to cover the insurance premiums. In order for the contributions to qualify for the grantor’s annual gift tax exclusion, notice must be provided to the beneficiaries by the trustee. The notice, often called a Crummey letter, notifies the beneficiaries of their right to withdraw contributions, which, in turn, meets the Internal Revenue Service’s “present interest” requirement for the gift to qualify for the annual gift tax exclusion. The Crummey withdrawal period does lapse, typically 30 days after the date of the gift. The trustee can use the gift/contribution to pay the insurance premiums after the withdrawal right period ends.

Gifting Existing Life Insurance Policies to a Trust
The IRS has a three-year lookback period after an existing life insurance policy is transferred to a trust to determine whether the death benefit can be included in the grantor’s estate. If the grantor contributes an existing policy to a trust, but then passes within the three-year window, the proceeds could revert into the grantor’s estate, thereby defeating a primary purpose of establishing the trust. Another factor to consider is that there may be a gift tax consideration if the existing policy has accumulated cash value. When a trustee purchases a new life insurance policy in the trust after the trust is established, there is no lookback period. When considering the tax consequences of any transfer, a competent tax adviser should be consulted.

Choosing the Right Trustee
The decision of who to appoint as the trustee for a life insurance trust is a critical factor in the success of the estate plan. There are several important duties that the trustee is responsible for carrying out for the purpose of the trust to be achieved. A primary purpose of an insurance trust is often to remove the value of the insurance policy, the annual contributions, and the resulting insurance death benefit proceeds from a grantor’s estate. For this purpose to be achieved, the trustee cannot be the grantor or the grantor’s spouse. The trustee will be responsible for the filing of tax returns, payment of insurance premiums, issuing Crummey notices to beneficiaries to ensure annual contributions qualify for the grantor’s annual gift tax exclusion, and distributing trust proceeds in accordance with the terms of the trust and the grantor’s intent.

An important consideration for choosing the trustee of an insurance trust is the chosen trustee’s ability to manage consistent premium payments, legal responsibilities, tax filings, and notice requirements. Often, a professional or corporate trustee is the best option for an insurance trust because of the level of complexity and administrative work that must be carried out for these trusts.

Deciding a Trust Jurisdiction
Choosing where an insurance trust will be domiciled is an important decision when establishing an insurance trust. Since an irrevocable trust can be domiciled anywhere, it is often advantageous to choose a state that affords the best combination of low insurance premium tax, no state income tax, and the best asset protection laws for irrevocable trusts. In most states, the situs of an irrevocable trust is based on the location of the trustee where the trust administration occurs among other basic requirements that differ slightly from state to state.

Want to learn more about Life Insurance Trusts?
What is a Life Insurance Trust?
How are Life Insurance Trusts Used?

How Are Life Insurance Trusts Used?

There are several common reasons life insurance trusts are used in an estate plan. Life insurance is an extremely valuable financial planning tool, that when combined with the flexibility and protections of a trust, provides some great benefits.

Provide Liquidity for Estate Administration
A common use for life insurance trusts is to provide an easily accessible source of liquidity for the insured’s estate upon their passing. As is often the case, many assets in an estate are illiquid, such as a house. Also, there is often an immediate need for liquidity after a person’s death. The estate may be required to pay taxes and will incur other administrative and legal costs. Therefore, many financial planners recommend a life insurance trust to provide liquidity for their client’s estate plans. When the insured passes, the life insurance proceeds are paid into the trust that is the policy’s beneficiary. These proceeds can then be used to purchase illiquid assets from the estate, thus providing protection for those assets and cash for the estate’s needs. A real-world example where this strategy might be used is to protect a surviving beneficiary, perhaps the spouse or a child of the insured, from being forced to sell a home on short notice to raise cash.

Minimize Federal Estate Tax Liability
Although life insurance proceeds are usually exempt from income taxes, proceeds are not exempt from estate taxes when the insured personally owns or controls the policy. Compared to personally owning an insurance policy, a key benefit of an ILIT is that the trust is the beneficiary of the policy, and the assets owned by the trust are not considered part of the insured’s taxable estate. For insurance proceeds to pass outside of the insured’s estate, the trust must own and be the beneficiary of the insurance policy.

Maximize Generation-Skipping Transfer Tax (GST) Planning Opportunity
An insurance trust can be used to maximize a grantor’s GST tax exemption by using annual gifts to the trust to fund the insurance premiums. Since insurance proceeds in a properly structured insurance trust are excluded from the grantor’s estate, multiple generations of the family may benefit from the trust’s assets free of GST tax.

Avoid Gift Tax
A life insurance trust can be structured in a way that allows the grantor to maximize their annual gift tax exclusion each year with contributions to the trust. Annual gifting enables the trustee to pay the annual insurance premiums while removing a significant amount of assets from a grantor’s estate over time.

Maintain Government Benefits
If a beneficiary is currently receiving government aid, such a Social Security disability income or Medicaid, a life insurance trust can be used to ensure that life insurance proceeds and ongoing distributions from the trust will not interfere with the beneficiary’s eligibility for government benefits.

Stipulate the Distribution of Funds
With a life insurance trust, the grantor can stipulate in the terms of the trust how the insurance proceeds are to be distributed. The trust can provide the trustee with discretionary powers to make distributions to beneficiaries. This could be useful in incentivizing certain achievements, such as graduating from college, or to protect the assets for the intended beneficiaries in blended family situations.

Protect against Creditors
A properly drafted insurance trust can provide asset protection for the life insurance policies held in trust. An irrevocable trust can provide asset protection from creditors of both the grantor and the beneficiaries. Once distributions are made from the trust to a beneficiary, a creditor of the beneficiary can attach any distribution, but as long as assets are held in trust, they can retain creditor protection. Asset protection laws vary from state to state, and several states, including Alaska, Nevada, and Delaware, offer excellent protections for trusts.

What is a Spousal Lifetime Access Trust (SLAT)?

By Jamie Rowley and Mariam Hall

A Spousal Lifetime Access Trust (SLAT) is an irrevocable trust created by one spouse for the benefit of the other spouse. The grantor uses their gift tax exemption to make a gift to the SLAT for the benefit of their spouse. Similar to other planning techniques to make completed gifts that are outside of the grantor’s estate, the grantor gives up his or her right to the property transferred into the trust while the beneficiary spouse maintains access to that same property.

The goal of a SLAT is to get assets out of a grantor’s estate and into a trust that can provide financial support for one’s spouse while sheltering those assets and any future growth from estate and gift tax. By creating a trust for one’s spouse, the grantor may continue to benefit from the property through the spouse without concern of creditor claims or estate tax inclusion.

Benefits of a Spousal Lifetime Access Trust

SLATs are used for many reasons, including minimizing estate taxes, avoiding gift taxes, reducing or eliminating capital gains tax, protecting assets from creditors, and taking advantage of grantor income tax rates. Read more here to learn about the benefits of Spousal Lifetime Access Trusts.

Key Considerations When Creating a SLAT

There are several important considerations to keep in mind when setting up a SLAT. For example, who will be the trustee as the grantor should not serve as trustee? Who will the beneficiaries be – Spouse, children, other descendants? Do you want to assign a trust protector and what duties will be assigned to them, such as the power to remove a trustee? How will the trust be funded? Are both spouses using a SLAT? If so, it is very important to avoid reciprocal trust doctrines. Do you need language regarding the possibility of divorce? Learn more here about the key considerations when creating a SLAT.

If you have more questions about a Spousal Lifetime Access Trusts, get in touch with a trust officer at Peak Trust Company today!

When is a Non-Grantor Trust Preferable?

Grantor trusts became one of the most commonly used tools for estate tax planning beginning with the enactment of the Tax Reform Act of 1986 (P.L. 99–514), which substantially reduced the increases in federal income tax rates. Two major perceived benefits have been (1) to allow the trust to grow free of income taxes because the income of the trust is attributed to the grantor1 and (2) the ability of the trust’s grantor to sell appreciated assets to the trust without a gain or other income recognition in exchange for a note. This note typically has interest at the applicable federal rate, and this interest is not taxed as income. Instead, the position of the Treasury and the Internal Revenue Service (IRS) is that the grantor will continue to be treated as the owner of the trust assets for federal income tax purposes.2

Grantor trusts also offer other benefits. For instance, the grantor, or the grantor’s spouse under Section 1041, can buy low basis assets from a grantor trust before death and achieve an automatic (commonly called a “tax-free”) change in basis upon death. Moreover, a grantor trust whose grantor is a U.S. individual taxpayer is automatically a qualified S corporation shareholder.3