For married couples seeking tax savings and lifetime access to cash, a spousal lifetime access trust (SLAT) has become increasingly popular in estate planning in recent years, and for good reason: It provides flexibility for couples wary of making large gifts to an irrevocable trust.
Traditionally, the irrevocable life insurance trust (ILIT) has been the liquidity planning technique of choice for married couples facing potential estate taxes. An ILIT is typically funded with a gift or series of gifts.
The gifted funds are used to purchase life insurance. If properly drafted and funded, ILIT ownership of life insurance removes the policy cash value and death benefit from a couple’s taxable estates. However, the ILIT sometimes causes a significant tradeoff; control over funds gifted to an ILIT is lost forever, and this loss of control extends to life insurance cash value.
What is a SLAT?
In its most basic form, a SLAT is an irrevocable trust created by one spouse to benefit the other spouse. It takes a standard life insurance trust to the next level by unlocking life insurance cash values for living needs.
A SLAT is often drafted as a grantor trust where the grantor and the trust are considered one and the same for income tax purposes (IRC Sections 671-679 contain the grantor trust rules). This grantor trust status enables trust assets to grow free from income tax erosion, resulting in greater potential wealth transfers to the heirs.
The beauty of the SLAT is in its lifetime access provisions, which allow for discretionary (and sometimes mandatory) distributions of income and principal to a spousal beneficiary during the spouse’s lifetime. In the life insurance context, cash value can be distributed to a spouse-beneficiary during the spouse’s lifetime.
After the spouse’s death, other beneficiaries such as children or grandchildren would be next in line. The lifetime access provisions are crucial and this type of flexibility is unavailable in a standard ILIT.
To avoid estate inclusion of the life insurance policy in the beneficiary’s estate, the access provision is limited to an “ascertainable standard” (as governed by IRC Sections 2041 and 2514). In other words, the spouse cannot have unfettered access to policy cash value. Distributions are made by the trustee for specific purposes governed by the tax code such as for health, education, maintenance and support, also known as a HEMS provision. The good news is that the HEMS universe is large enough to cover most lifetime needs.