Spousal Lifetime Access Trusts – A Popular Planning Strategy

Many clients who assumed that the November 3rd election would bring a “blue wave” were planning to make a large gift before the end of the year to use most, if not, all of their remaining gift/estate tax exclusion, $11.58 million per person ($23.16 million per married couple) and increasing to $11.7 million in 2021 under current law. Now, the approaching question regarding a Biden presidency is whether that exclusion will be reduced before 2026 if the Republicans still control the Senate – an outcome that won’t be known until after the two Senate run-off elections in Georgia in early January. 

Regardless of how control of the Senate plays out, there are good reasons for donors to use their exclusion now, including the following: (1) the sooner property is transferred, the more appreciation is likely to be removed from the donor’s  estate, and (2) taking a more thoughtful approach to wealth planning transfers avoids a last-minute rush and potentially hasty decisions.

A popular planning strategy for using a married couple’s gift/estate tax exclusion is for one or both of the spouses to create a spousal lifetime access trust (“SLAT”).  This is simply a trust that one spouse sets up for the other spouse and their children/grandchildren.  Because the other spouse is a trust beneficiary, the donor spouse has indirect access to the trust property if he or she needs it.  Of course, if the spouse/beneficiary predeceases the donor spouse or the spouses divorce, this indirect access disappears.  This is why both spouses typically set up a SLAT for each other.  However, the trusts have to be different enough so that the “reciprocal trust” doctrine doesn’t apply – meaning that the separate trusts are effectively ignored and each spouse is treated as creating a trust for himself or herself that is  still includible in that spouse’s estate.

Nevertheless, one spouse often has most of the wealth, with the other spouse not having nearly enough   to set up a SLAT for $11.58 million for the wealthier spouse.  In this case, the wealthier spouse often transfers funds to the other spouse so that spouse can create a SLAT.   How long does the less wealthy spouse need to “hold” these funds before transferring them to a SLAT for the donor spouse?  Although there is no hard and fast rule, if the transfer is “too soon,” the IRS could assert that that there was an implied agreement that the recipient spouse would use the funds to create a SLAT.  As with the spectre of the reciprocal trust doctrine, the donor spouse could be treated as having created the trust for himself or herself, thereby making the trust includible in this spouse’s estate and defeating the trust’s purpose.

If a couple is not comfortable giving away $23.16 million in assets but would be comfortable giving away something less, the wealthier spouse could use that spouse’s gift/estate tax exclusion to create a SLAT for the less wealthy spouse. This way if the gift/estate tax exclusion is reduced, say, to $5 million, only one spouse will lose the exclusion of $6.58 million.  If both spouses use $5 million of their respective exclusions, and that exclusion is later reduced to $5 million, neither spouse would have any exclusion left after the reduction, and $13.16 million of it would be lost.

In summary, even though, post-election, clients are less certain that the estate/gift tax exclusion will be reduced before 2026, they should move forward with plans to use the exclusion now rather than later.