As a result of the pandemic, the global economy and US tax conditions have resulted in unprecedented estate planning and wealth transfer opportunities. When combined with historical policies and existing estate planning tools, there are opportunities for individuals and families to consider long-term plans for their wealth while keeping more of their assets for loved ones.
Interest rates are historically low. In addition to this, the lifetime gift tax is higher than ever before, at $11.58 million. However, this figure is set to revert back to $5.5 million in 2026, which means the time is ripe for estate planning now. Putting it off can result in a much higher tax liability.
The estate planning process can be complex. There are a tremendous number of wealth transferring tools that can be employed to address unique family situations and asset transfers. Two tools are the Spousal Lifetime Access Trust (SLAT) and the Grantor Retained Annuity Trust (GRAT). These are complex tools for advanced estate planning. It’s worth knowing a bit about how they work to determine if they might accomplish some of your estate planning goals.
Spousal Lifetime Access Trust (SLAT)
The spousal lifetime access trust, or SLAT, is an irrevocable trust set up by a donor spouse so that the beneficiary spouse can access benefits. Effectively, the spouse setting up the trust, or donor spouse, removes the assets from the taxable estate by putting them in this type of trust, which allows the beneficiary to access distributions of income and/or principal without appointing an independent trustee. Since it is irrevocable, the terms of the trust cannot be modified, amended, or terminated without the express permission of the beneficiaries.
Additionally, each spouse can establish a SLAT for the other spouse, provided that they are considered “ non-reciprocal,” which allows them to be excluded from the other assets in their taxable estate. In order to do this, though, the SLATs must be materially different from one another. They cannot be identical.
Each spouse may also use their lifetime federal gift tax exclusions of $11.58 million per person when putting assets into a SLAT. The other primary benefit of a SLAT is that the family retains access to the assets and their appreciated value that can be used for the rest of their lives. It is an ideal tool for married couples who would like to employ the gift tax exclusion but cannot lose access to their assets without negatively impacting their standard of living.
SLATs are an attractive option when asset values are low. They are also great for clients with a high net worth seeking ways to minimize their future tax liability but must also consider preserving enough assets for the remainder of their lives. When the beneficiary spouse passes away, the trust assets will pass to any beneficiaries specified by the trust.
Because significant changes may be coming to estate taxes, we recommend that you inquire about a SLAT sooner rather than later.
Grantor Retained Annuity Trust (GRAT)
Like a SLAT, a GRAT is an irrevocable trust. It allows an individual (the grantor) to transfer wealth to others with little to no gift or estate tax. It is governed by Section 2702 of the IRS Code. The grantor transfers assets to the trust while retaining the right to receive an annual amount, or annuity, for a term specified by the trust. This term can be as short as two years. Normally, the annuity is a fixed amount, although the GRAT can be structured to allow for graduated annuity payments that increase by up to 20% annually.
Once the term is up, the remaining assets are distributed to the remainder beneficiary, which is often a member or members of the grantor’s family. While the transfer of property to the trust is a taxable gift from the grantor, the annuity payments are often structured so that the value of the remainder assets – and the gift tax – is minimized or eliminated.
At this time, the annuity’s present value is reduced from the total amount of assets initially transferred to the GRAT to determine the amount of the gift. The GRAT’s value is also based on the term and interest rate that are determined monthly under Section 7520 of the IRS code, which fluctuates with market interest rates. Since these rates are currently lower than average, the GRAT is currently a very attractive estate planning option. In most instances, the annuity’s present value will equal the amount transferred into the GRAT, resulting in a zero gift amount.
Despite these benefits, there are a few cautions when working with GRATs. The Generation-Skipping Tax exemption will only be valid until the GRAT’s term expiration, meaning that it is best to name only surviving children as beneficiaries. Additionally, if the grantor dies before the annuity term ends, the assets would revert to the grantor’s taxable estate.
Working With Both SLATs And GRATs
In estate planning, it is common to work with multiple financial planning and tax savings tools to circumvent some of the pitfalls that may be encountered when using just one method. GRATs and SLATs can work together. In these circumstances, a married couple may be able to make better choices about their entire estate and how assets should be distributed in a way that provides for the remainder of their lifetime and minimizes the tax liability for their beneficiaries.
And while it is possible to create an estate plan that offers the advantages of both of these types of trusts, it can become complex quickly. And it is absolutely imperative that you do not proceed with any actions that would invalidate the terms of the trusts or run afoul of the tax rules. Examples of risky actions include setting up identical SLATs for both spouses or naming a SLAT as the beneficiary of a GRAT’s remainder assets).
Ultimately, it is a great time to consider either of these trusts – or both in tandem – as estate planning strategies, especially in light of proposed changes to estate tax law (the For the 99.5% Law). This allows you to take advantage of the higher lifetime gift tax limit and low-interest rates. However, before moving forward with executing either of these trusts, it’s a great idea to consult with an expert estate planning attorney to ensure that no detail is left out.
