Traditionally, an irrevocable life insurance trust (ILIT) has been an estate planning technique created to own life insurance outside of an estate. However, with the ever changing landscape of federal estate and gift taxes, married clients may desire a more flexible estate planning solution. One option is a protection spousal limited access trust, or SLAT.
A SLAT is a flexible irrevocable trust that provides lifetime access to trust assets for the non-grantor spouse while still keeping the death benefit outside the client’s estate. Typically, a SLAT trustee can make lifetime distributions to the non-grantor spouse for his or her ascertainable standards (i.e., health, education, maintenance or support). The assets in the SLAT also may be protected from a client’s future creditors because it is outside of the estate.
A protection SLAT requires a large gift of an income-producing asset or cash that is invested in an income-producing asset. This gift will use some or all of the client’s lifetime gift tax exemption. Once the asset is given to the SLAT, the income produced will be used to pay premiums to the life insurance policy for a certain period of time. The grantor will be taxed on this income because the SLAT will be a defective trust for income tax purposes. Once the policy is paid up, the income can be distributed to the non-grantor spouse according to the terms of the trust.
Consider the following clients: Glen (age 52) and Tonya Jones (age 48) are married and have two children. Together, they have an estate worth $8 million. They are interested in using part of their lifetime gift tax exemption by giving a $1 million investment account to the SLAT, but they’re concerned about retaining access to the account. They also want to fund life insurance in an ILIT to pay for potential estate taxes, but they want flexibility for any changes life brings.
In this case, Glen will set up a SLAT and name Tonya as the beneficiary of the trust for discretionary distributions of principal and income for her health, education, maintenance or support. Next, Glen will give ownership of the $1 million investment account to the SLAT using his lifetime gift exemption amount. The SLAT will be set up as defective for income tax purposes, so Glen will pay tax on income generated by the trust assets.
Once the investment account is given to the trust, the income will be used for 17 years (until Tonya retires) to fund a second-to-die life insurance policy. At the end of this period, the life insurance policy will be paid up and guaranteed to age 120 with no further premium payments. The return from the investment can be distributed to Tonya based upon the discretionary distributions from the SLAT. When both Glen and Tonya pass away, their children will receive the death benefit and the principal of the investment account.
For more on trusts, see: