By Dara Lynn S. Freytag
With the Baby Boomers passing on their wealth to the next generation, the most significant transfer of wealth is currently occurring. Although the current federal estate and gift tax exemption offers a generous opportunity to transfer wealth (i.e., currently $11.7 million per individual and $23.4 million per couple), there is no guarantee that this exemption will remain in place in the current political climate. Even if left untouched, the federal lifetime estate and gift tax exemption is scheduled to revert back to approximately $5.5 million per individual on January 1, 2026.
This realization makes estate planning even more important for anyone who wants to pass on generational wealth right now. There are a number of tools and techniques that we use in developing an estate plan that can be effective in minimizing the tax burden associated with these transfers. Which planning tools and techniques you choose to include within your personal estate plan will depend on many factors, one of which is how much control you wish to retain over your wealth when it passes onto your designated heirs.
One course of action that has proven to be effective is to establish an irrevocable trust during your lifetime for the benefit of one or more beneficiaries. At the time the trust is drafted, you will dictate who the beneficiaries will be, who will administer the irrevocable trust, and how the assets are to be allocated, administered and eventually distributed. Placing your assets in an irrevocable trust allows you to use a portion of your federal lifetime gift tax exemption, and any appreciation of those gifted assets will remain outside of your taxable estate when you pass away. Although the grantor can retain some controls over the irrevocable trust, the grantor is unable to retain any controls over the distribution of assets once they are gifted to the irrevocable trust.
Many of our married clients are taking steps to establish an irrevocable trust called a spousal limited access trust (SLAT). The Settlor spouse, or “creator” of the irrevocable trust, establishes a SLAT for the benefit of his or her spouse and their current (and future) descendants. After the SLAT is established, the Settlor uses a portion, or even all, of the Settlor’s lifetime gift tax exemption when transferring property to the SLAT (e.g., real estate, cash, investments, company shares, business interests, life insurance, etc.). For certain assets, the value of such property on the date of transfer is determined by a qualified appraiser. Any appreciation of such gifted assets will be outside of the Settlor’s taxable estate and the taxable estate of the Settlor’s spouse. Even though the Settlor no longer retains any interests or controls over the assets transferred, the Settlor’s spouse is a named beneficiary of the SLAT and, depending upon the terms of the SLAT, may receive distributions of income and/or principal during the beneficiary spouse’s lifetime.
Structured correctly, a SLAT will be excluded from your taxable estate and your spouse’s taxable estate. A SLAT is established as a “grantor trust” meaning that any income the SLAT earns is taxable on the Settlor’s personal income tax return, which can serve to further reduce the Settlor’s taxable estate.
The Settlor cannot act as a Trustee of the SLAT. However, the beneficiary spouse can serve alone as sole Trustee of the SLAT or as a co-Trustee with an Independent Trustee (i.e., family member, friend, attorney, CPA, CFA, bank or trust company). If the beneficiary spouse is going to serve as sole Trustee at the outset, then the distributions from the SLAT to or for the benefit of the beneficiary spouse will be based on an ascertainable standard, i.e., for health, education, maintenance and support in reasonable comfort of the beneficiary spouse. Alternatively, if an Independent Trustee is selected to serve as sole Trustee, or as a co-Trustee of the SLAT with the beneficiary spouse, then the Independent Trustee will have broad discretion to make distributions from the SLAT for any purpose to or for the benefit of beneficiaries, including the beneficiary spouse.
Estate planning is a complex and continually changing environment. A spousal limited access trust is one of the many tools estate planners can use to address the desire to preserve and protect assets. It is important that you work closely with a qualified trust & estate attorney to develop a plan that meets your individual needs.
Dara Lynn S. Freytag is an Attorney in the Estate Planning & Administration Practice Group at Tarlow Breed Hart & Rodgers, P.C. in Boston, Massachusetts. Attorney Freytag can be contacted at (617) 218-2081, or via email at firstname.lastname@example.org.