Estate Planning for the Happily Married

One of the biggest challenges of estate planning is dealing with uncertainty. For 2022, for example, the federal gift and estate tax exemption is $12.06 million, but it’s scheduled to be cut in half after 2025. And some lawmakers would like to shrink it even more. Given this uncertainty over the exemption’s future, it’s wise to take steps now to lock in the current exemption amount by transferring assets to your children or other heirs — either directly or in a trust — before the exemption is reduced.

At the same time, there’s growing economic uncertainty. If you give away substantial amounts of wealth now, what happens if financial circumstances change for the worse at some point and you’re in need of additional funds? If you find yourself in this position, and you’re happily married, one potential strategy for hedging your bets is a spousal limited access trust, sometimes referred to as a spousal lifetime access trust (in either case, abbreviated as SLAT). Properly designed, a SLAT allows you to transfer assets up to your unused exemption amount tax-free, while providing a financial safety net if you need access to those assets down the road.

Lose direct access to assets, but gain indirect access

To take advantage of a SLAT, you transfer assets to an irrevocable trust that benefits your spouse during his or her lifetime, with any remaining assets passing to your children or other heirs. Because the trust is irrevocable, the assets you transfer to it are completed gifts for estate tax purposes. That means their value, together with any future appreciation or earnings, are removed from your taxable estate. Most important, your gifts are shielded from gift tax up to your current unused exemption, protecting you from possible future reductions in the exemption amount.

Here’s how a SLAT allows you to hedge your bets: Although you must give up your assets to gain the tax benefits described above, you continue to have indirect access to your wealth through your spouse, who’s a beneficiary of the trust. Usually, the best way to accomplish this is by appointing an independent trustee with full discretion to make distributions to your spouse or, alternatively, with the power to make distributions to your spouse under specified conditions.

Two SLATs are better than one

One way to reduce the risk of losing a spousal lifetime access trust’s (SLAT’s) benefits if your spouse predeceases you is for each spouse to establish a SLAT for the benefit of the other. For this to work, of course, each spouse must fund their SLAT with separate property. Thus, you may need to retitle or transfer assets to ensure that each spouse has sufficient separate property to fund each SLAT.

If you use two SLATs, be sure the trusts aren’t “mirror images” of each other. If they’re too similar, the IRS may invoke the reciprocal trust doctrine. Under that doctrine, if the IRS concludes that the two trusts place you and your spouse in roughly the same economic position as if you each created a trust for your own benefit, it can undo the arrangement and bring the assets back into your respective taxable estates.

To avoid this result, be sure that the two SLATs are sufficiently different that they can’t be viewed as a quid pro quo for each other. For example, you might establish the trusts at different times or include terms in one trust (a special power of appointment, for instance) that aren’t included in the other.

Control of assets is critical

To ensure that a SLAT achieves your objectives, it’s important that it’s drafted carefully. For example, you must avoid retaining too much control over the trust assets. Otherwise, they may be pulled back into your taxable estate. That means you shouldn’t act as trustee or otherwise wield power over the trust, and the trust should prohibit distributions that would satisfy your legal support obligations to your spouse.

Care must be taken to keep the trust assets out of your spouse’s estate as well. So, it’s best not to name your spouse as trustee or, if that’s unavoidable, consider limiting distributions to those necessary for his or her health, education or support.

Also, gifts to the trust must be made with your separate property. Gifts of jointly owned or community property may be included in your spouse’s taxable estate. After the trust has been funded, be sure that its assets aren’t commingled with marital assets.

Understand the risks

The advantage of a SLAT is that even though it’s irrevocable, it provides you with indirect access to the trust assets through your spouse. Thus, to preserve this advantage, your marriage must remain strong.

If you get divorced, you risk losing the safety net provided by a SLAT. You also risk losing a SLAT’s benefits if your spouse dies before you do. One strategy for mitigating this risk is for each spouse to set up a SLAT. (See “Two SLATs are better than one” above.)

Have your cake and eat it too

Under the right circumstances, and with careful planning, a SLAT can enable you to “have your cake and eat it too.” It allows you to enjoy the tax benefits associated with irrevocable gifts, while retaining indirect access to your wealth in case your financial circumstances change.

Disclaimer: The THK Legal Blog is for informational purposes only and should not be relied upon as legal advice. In no case does the published material constitute an exhaustive legal study, and applicability to a particular situation depends upon an investigation of specific facts. You should consult an attorney for advice regarding your individual situation. All THK blogs are considered advertising material by the Indiana Bar Association.