By Dr. James M. Dahle, WCI Founder
Regular readers will recall that our financial goals for 2021 included finally getting serious about our own estate planning. We're not proud to admit how long we waited to do this but are proud that we actually did it! A major part of our estate plan is a Spousal Limited Access Trust, sometimes called a Spousal Lifetime Access Trust, both abbreviated as SLAT.
Let's talk about what it is and why you might want to consider it.
What Is a Spousal Limited Access Trust (SLAT)?
Let's start by breaking down what a SLAT is by defining each of the terms.
- Spousal – The primary beneficiary of a SLAT is your spouse.
- Limited – The trust is often written so that the spouse can only access the contents of the trust to provide for their own health, education, maintenance, or support.
- Lifetime – Further provisions kick in when the primary beneficiary spouse dies.
- Access – This refers to the fact that the donor spouse still has access to the assets of the trust through the beneficiary spouse.
- Trust – A SLAT is an irrevocable trust, and, thus, the assets in it are removed from the estate.
At its most basic, a SLAT is a grantor trust set up by the donor spouse for the benefit of the beneficiary spouse. “Grantor trust” simply means that the donor spouse is responsible for the taxes on income in the trust; the trust does not file its own tax return.
What Is the Real Purpose of a Spousal Limited Access Trust?
What's the point, you may ask? Obviously, if you have a spendthrift spouse, this is a way to make sure the spouse is taken care of, but that's not usually the point of setting up a SLAT. The main idea behind a SLAT is reducing the estate tax paid. This is generally a trust used only by those with an “estate tax problem,” i.e. an estate that is or will be larger than the federal and any applicable state estate tax exemption amount at death. In 2022, that amount is $12.06 million per spouse, indexed to inflation. Under current law, that amount will be cut in half as of 2026, but Congress has discussed reducing it even before then.
How Does a SLAT Reduce Estate Tax?
A SLAT reduces estate tax through two mechanisms. The first is by removing any additional growth on an asset from the estate. The idea is to put assets into the SLAT that still have a long way to grow in value. That might be a small business, a farm, real estate investments, or a brokerage account. You fund the trust either gradually using gifts or, more likely, all at once using your estate tax exemption. Perhaps you put in $12.06 million in assets, using up your entire exemption, and then the assets grow to $30 million between the time the trust was funded and death. None of that $30 million will be subject to estate tax.
The second way a SLAT reduces estate tax is by purchasing additional rapidly growing assets from you in exchange for a promissory note. Imagine you have a $50 million business. You can gift $12.06 million into the SLAT and then the SLAT can buy the other $37.94 million with a promissory note. That note can have all kinds of terms (30 years, interest-only, etc.). However, there is a minimum interest rate that must be paid. In our current low-interest rate environment, that rate is less than 2%. Fixed. So as long as the asset you put into the SLAT performs better than that, you are increasing the percentage of your assets inside the SLAT while decreasing the percentage that is outside of the SLAT, further reducing any potential estate tax bill.
SLAT Trusts and Asset Protection
If you're interested in asset protection, the assets in a SLAT are protected from creditors of the donor, since the donor has effectively given away the assets. They are also protected from the creditors of the beneficiary, since the trust probably only pays out amounts for health, education, maintenance, and support (although other options are available). In fact, the trust can pay for those services directly, never actually paying cash to the beneficiary. Thus, there is no cash for the beneficiary's creditors. Even better, the trustee can simply not pay out anything, and therefore, there is no cash available to the creditors, inducing them to settle with the beneficiary.
Unfortunately, if there is a promissory note outside of the trust, the value of the note and the income associated with it may be available to the donor's creditors. However, there may be other methods of protecting that asset, such as placing it into a Domestic Asset Protection Trust (DAPT) in states that allow it. While that asset will be subject to estate tax and income tax, it will not be subject to creditors.
What About Living Expenses and Taxes?
You do not want to impoverish yourself by funding the SLAT. The grantor will still need money to live on and enough money to pay all of the taxes due on the income of the trust. Where will that come from? It either needs to come from other assets or from the payments on the promissory note. In our prior example: with a 1.8% interest rate and a $37.94 million note, the interest would be almost $700,000. While that sounds like plenty to live on, it might not go very far if the trust is producing $5 million in income each year. The tax bill on that might be $2 million or more per year. If you have a lot of assets outside of the trust, no problem. Using that money to pay the tax bill further reduces your estate tax problem. If you do not have a lot of assets outside of the trust, you might want to have a shorter note. For example, a 10-year 1.8% note would be paying out more than $4 million per year. That would cover the tax bill and living expenses, at least until the note is paid off.
The idea is that you let the value of the SLAT grow as much as possible, and in the meantime, you use the promissory note payments and other assets to pay living expenses, taxes, and charitable contributions.
Grantor, Beneficiaries, Trustees, Trust Protector
There are lots of different roles involved here. The Grantor is the one who funds the trust. The Beneficiary is the one who benefits from the trust. The Trustee is the person who manages the assets and distributions. The Trust Protector is the person who can replace the trustee in the event of misconduct. With a SLAT, the grantor cannot be a trustee and the beneficiary probably should not be—or at least there should be a co-trustee. The Grantor should not be a beneficiary, at least initially but can be added later. It is best to list all potential beneficiaries, at least in general terms, when the trust is first drafted. That would include the spouse as the primary beneficiary. As secondary beneficiaries, you could include children, other relatives, the donor spouse, a donor-advised fund, and/or a private charitable foundation. One suggestion from our attorney was that a family member of the beneficiary spouse serves as the trustee and a family member of the donor spouse serves as the trust protector.
The Reciprocal Trust Doctrine
If one SLAT is a good idea, aren't two better? One SLAT can be funded by the first spouse for the beneficiary of the second, and a second SLAT can be funded by the second spouse for the beneficiary of the first. This would allow you to use the exemption amounts of both spouses, thus doubling the amount that can be gifted into the trust. You have to be careful with this, though. Both the IRS and the courts may view two identical trusts as simply “reciprocal trusts” and view them as your own trust, negating any tax and asset protection benefits. The key to avoiding this is to not set up both trusts at the same time. You can also vary the terms and the beneficiaries of the trusts to avoid having the reciprocal trust doctrine apply.
Another benefit of not setting up two SLATs at once is that you preserve flexibility to set up another one in the event that estate planning laws or exemptions change in the future or simply to pass some non-trust assets to heirs without paying estate taxes.
8 Downsides of a SLAT Trust, and What You Can Do About Them
It all sounds great so far, right? Naturally, there is no free lunch. SLATs do have downsides, so you need to be aware of them.
#1 Cost and Hassle
You will generally spend thousands of dollars setting up and maintaining a trust like this. You will also need to fund the trust. All income from the asset must stay in the trust and all expenses for the asset must come from the trust. Good drafting of the trust document can minimize hassle, but there is no way around the expense.
There is no point to a SLAT if there is no estate tax problem. If there is an estate tax problem, the costs of the SLAT should be dwarfed by the available estate tax savings. A gift tax return will also need to be filed in the year the trust is funded.
#2 Divorce
What happens if you put all your money into a SLAT and then divorce the beneficiary spouse? Seems problematic, right? Luckily, provisions can be put into the trust document to take care of this (such as that the beneficiary is the CURRENT spouse or that, in the event of divorce, both spouses will be beneficiaries).
#3 Death of the Beneficiary Spouse
If the beneficiary spouse dies, the donor spouse loses access to those assets as they will pass on to the secondary beneficiaries. A testamentary limited power of appointment may overcome this limitation of a SLAT. I say “may” because it appears to be somewhat controversial. However, the way it is supposed to work is relatively simple—the will of the beneficiary spouse names the donor spouse as a beneficiary of the trust or, more commonly, as the beneficiary of a new trust formed at the death of the beneficiary spouse and funded with the assets of the SLAT.
#4 Loss of the Step-Up in Basis at Death
You should think twice before putting an asset into a SLAT that you plan to hold until your death. For example, if you hold the family farm until you die, your heirs will receive a step-up in basis as of the date of your death, reducing any income tax due when they sell the farm. Assets inside a SLAT do not get a step-up in basis at death. It is entirely possible that, for an asset held until death, the income taxes due are greater than any applicable estate taxes! So the SLAT strategy works best for assets that are likely to be sold prior to death. Paying the capital gains taxes from the assets outside of the SLAT further reduces the estate tax bill by lowering the size of the taxable estate.
If the SLAT contains more marketable securities, there is another option. The SLAT can have a “swap option” that allows the grantor to swap out low-basis shares inside the SLAT for equivalent but high-basis shares outside the SLAT. Once outside the SLAT, the low-basis shares can be used for charitable gifting, or they can qualify for the step-up in basis at death.
Note that the interest on the promissory note is not taxable, nor is it a taxable event to sell assets to the trust. This is the benefit of a grantor trust. The downside? That all the taxable income passes through to the donor. I worried this would be a big problem if the SLAT eats the rest of our financial life and we end up with 99% of our money in the SLAT somehow and no way to cover the tax bill from other assets. The way around it is to write a provision into the SLAT that allows it to reimburse you for taxes paid.
#5 You Need People to Trust
Trust is not just a noun; it is also a verb. Trusts work best when you can actually trust everybody involved—the grantor, the beneficiaries, the trustees, and the trust protector. While safeguards can be instituted (such as including a trust protector), it is best to give careful thought to the people involved with the trust.
#6 Donate Only Assets Owned by the Donor
Ideally, the donor will fund the trust only with assets owned solely by the owner. It negates the point of the trust to donate jointly owned assets. However, this one has an easy workaround. Spouses can give each other an unlimited amount of assets at any time. So, have the beneficiary spouse give the donor spouse the assets, and then the donor spouse can fund the trust with them. This can require additional paperwork in community property states.
#7 SLATs Are Ideally Only Used in an Emergency
The highest use of a SLAT is to maximize the amount of assets passed to heirs outside of the estate and, thus, to minimize any estate taxes due. The more that is left in a SLAT, the more money that is saved on estate taxes. While it can be used to benefit the beneficiary spouse, ideally it is not. The longer the term on any promissory note (interest-only is even better) and the fewer withdrawals to support the spouse, the better. However, if the beneficiary spouse (and also the donor spouse so long as the beneficiary spouse is alive or via the testamentary limited power of appointment) end up needing the assets, they can still be accessed. Be careful how much you put into the SLAT.
#8 Depreciating Assets Don't Go in a SLAT
Since the point of a SLAT strategy is to maximize the value of the SLAT at the death of both spouses, you only want appreciating assets in the trust. This is not the place for cars, boats, and consumer goods that are likely to depreciate in value. If you want those in a trust for privacy, for asset protection, or for avoiding probate, put them into a DAPT or a simple revocable trust.
Have more questions about estate planning or protecting your assets? Hire a WCI-vetted professional to help you sort it out.
If you are married with an estate tax problem and asset protection concerns, consider a SLAT as part of your estate plan. That's finally what we've accomplished, even if it took us a little longer than we expected.
What do you think? Do you have a SLAT? How did you structure it? Do you think the pros outweigh the cons? Comment below!
How much in start-up and recurring fees is a SLAT typically?
If you have to ask, you probably don’t need a SLAT. 🙂
Expect low five figures all in. I ended up paying almost as much to value the businesses put into the SLAT as all of our estate planning costs combined, including the SLAT.
Are there any repercussions if $12 Million in assets are placed in the trust now, but then the estate tax exemption is later decreased?
There’s no problem at all, what matters is what’s the exemption limit at the year you set up the trust, once trust is set, money is technically “not yours” anymore
No. In fact, that’s one great reason to use a SLAT. If it decreases, nothing bad happens. If it increases, you get to use all the increase.
I thought an unlimited amount could be passed on to a spouse without being subject to an estate limit?
Spousal exemption allows unlimited transfer upon death of a spouse, with stepped up basis. This is one of the issues , along with other issues such as potential tax complexities that deterred me from SLATs
I’m trying wrap my head around the benefit. This post was very well written, but I think I’m still missing something. Would the benefit be for the spouse to then transfer the SLAT to an heir upon his/her death?
I’m still not following why I wouldn’t just have assets grow in a brokerage account and then pass them to my spouse at death, with stepped up basis. (Obviously with much risk of future legislation changing the tax treatment of stepped up basis. The nice thing about this not being a boglehead site is this comment won’t get censored for noting that there is a probabilistic risk of future legislative change!)
The benefit is that you reduce estate taxes. Imagine you put a business in there that is worth $10 million. It then appreciates to become worth $100 million and you sell it. You just saved like $40 million in estate taxes.
There are also asset protection benefits for you and your heirs.
If you don’t have an estate tax problem, you don’t need a SLAT. This isn’t something most docs need.
Cost, complexity, and loss of step-up in basis are the primary downsides.
That’s correct, but it’s about when the second one dies.
I’ve been interested in SLATs ever since I heard of it. One question I have and can’t find answers online is when you have to pay federal inheritance tax, can that money come from pretax accounts? Example say when we die, we are $10M over the limit, need to pay $4M in tax, can this tax come from only my pretax account? Or it’s 40% of every single account I have? If I can pay inheritance tax with only pretax account I may not do a lot of Roth conversion and just leave it there to pay inheritance tax later.
There is no federal inheritance tax, only federal estate tax. Some states do have an inheritance tax too.
I think you’ve got to pull the money out of a pre-tax account (and pay taxes on it) before paying estate tax with it. But it doesn’t have to come out of every account. The IRS doesn’t care where the money comes from.
Are you sure you have to pull money out of pretax account and pay tax before the estate tax? I’m asking because any Roth conversion I do will be taxed at around 25%, or more and if my estate tax can come out of pretax that’s significant consideration whether to setup a SLAT or not
I’m not sure, but I think that’s the way it is.
Interestingly, according to Nolo, apparently heirs of an inherited IRA can take an income tax deduction for the estate tax paid on the inherited IRA.
https://www.nolo.com/legal-encyclopedia/question-estate-tax-shield-ira-funds-28397.html
You also can’t reduce the estate by the amount of tax that would be due on the IRA (thus why doing a Roth conversion would help):
https://www.journalofaccountancy.com/issues/2006/apr/canestatereduceirasvaluefortaxpurposes.html
But I couldn’t find anything that specifically said you couldn’t pay estate taxes with pre-income tax money. I don’t think you can though. It doesn’t make sense to me that you could.
The SLAT is used to lock in the current estate tax exemption. Once the SLAT is set up, it locks in the current ~12 million exemption per spouse because that amount was gifted at the time the SLAT was established, and that was the estate tax exemption at the time that the SLAT was established. Even if the estate tax exemption is reduced in the future, you still get the 12 million per spouse exempted from taxation when you have SLAT trusts.
It was recommended that we set up SLAT trusts in anticipation of the Biden presidency and all of the tax increases that would come along with that. The complexity and the cost was a huge negative. We chose not to do it.
If I die, my first responsibility is to my spouse, and there would be no estate tax owed by my spouse. If I had a complex estate plan including SLAT trusts, that would be a negative for my spouse in terms of managing the cost and complexity, and a positive for the next generation of heirs as there would be less estate taxes owed.
We decided that simplicity and taking care of the current spouse is more desirable than complexity, cost, and leaving every possible dollar for the next generation. Maybe that is a mistake, but that was our choice.
We passed last year for the same reason, but still considering it.
You set it up such that each spouse has plenty of their own money after funding the SLATs. The spouses live on these funds, not the money in the SLATs. The SLAT money is there if things go badly and they need it, but one plans not to need it. The trust then protects the amount inside them from estate taxes.
There would be no estate taxes due at the first death anyway. Married couples do not pay estate taxes when leaving money to one another. The SLAT does not save anything at the first death.
However, if the first to die leaves some money to others, say kids, then that would be subject to estate taxes. If the second to die were to leave money to the kids, then again estate taxes would be due.
The SLAT would give you the biggest bang if you each use up your entire exemption. However, any amount you put in would avoid estate taxes. Even if it is just a couple million.
Cost- we were quoted $12,000 each by a senior partner at a specialty estate planning firm in a big city. I assume you could do it for less but you do want to be sure your lawyer REALLY knows what they are doing.
Ongoing expenses. You need a trustee and as Jim noted, it can be safer to have neither spouse in that role. At the least, you need an independent trustee if there are going to be distributions. Maintaining the trust and avoiding mistakes that would ruin its tax benefits suggest using an experienced corporate trustee. Add those fees. Our law.firm would do it, we did not get as far as pricing but they said they would hire someone to manage the assets- more fees and someone doing active management.
Vanguard charges low fees by trustee standards. I have not checked whether they do SLATs but I assume they do. They would be $27,500 annually for a $5M trust. Times 2 if you did the normal thing and set up 2 trusts.
The idea is increase the value of what’s in the SLAT while decreasing the value of what’s outside the SLAT. So you use money outside the SLAT to:
1) Live on
2) Give to charity
3) Pay taxes
Once all the money outside the SLAT is gone, you can start paying down the principal on any promissory note. When that’s gone, you would have to make distributions from the SLAT for living expenses, charity, taxes etc.
Maybe someone from WCI should check in every once in a while on the forum re: rulebreaking. I fear retaliation from moderators, since a lot of them are in fact taking part in it
Not sure what type of rule breaking you are referring to. Can you clarify?
SLAT trusts are a legal way to get a break on estate taxes.
Stop posting anonymous comments on the blog complaining about forum moderation. Nobody reading this post and participating in the discussion afterward cares what is going on on some isolated thread on the forum or the FB group or whatever. If you have a problem with a step a moderator took, message another moderator. If you hate all the moderators, the forum is probably not a great place for you to hang out. Try the subreddit or FB group maybe.
Why not just put the (appreciating) assets in an LLC and gift ownership % of the LLC to the kids with the parents maintaining the managing partner role to control/limit/change distributions to the kids as the parents decide from year to year. Parents keep whatever % ownership they want and can continue to gift additional ownership to kids (or grandkids) in future years as anticipated financial needs of the parents decline (or parents can take a distribution of assets out of LLC if they need additional funds—this would reduce ownership percentage if only parents take out funds/assets. Set it up to allow the LLC the option to pay the (parent) managing partner for managing the LLC, if funds are needed by the parents. Keep enough non appreciating assets out of the LLC for expected life expenses of the parents. This gets the assets out of your estate, especially appreciating assets, it’s low cost to set up and maintain (with tight control of assets/LLC by parents), allows for the option to receive funds as a managing partner. Allows for easy future gifting of parent’s ownership in LLC to kids or grandkids without needing to hire estate planning attorneys, change ownership titling, etc. No need for expensive lawyers to set up, maintain, or distribute assets.
Not saying this is the best way, but it seems much more simple, cost effective. Thoughts?
That’s another option, but the LLC needs a business purpose besides just holding assets like a taxable account. A family LLC or family LP is a great way to pass on a family business, but not a bunch of other assets.
I think I’d probably still involve an estate planning attorney if that were my plan.
What Jim said about needing a business for the LLC or LLP to operate. Plus, setting up and managing the structure is not free.
Plus, outright gift of partial ownership of the LLC does not keep the assets out of the estates of the kids. You would still need an irrevocable trust for that.
Plus, the assets held in the LL by the general partner would still be in their estate.
Take away the complexity of the LL structure and this is just giving the money directly to the next generation. While alive, the parents would maintain more control of the business, if there were one, than if they made an outright gift. That may not even be a goal of many people who just want to reduce estate taxes.
The SLAT is a good solution for estate planning if the couple fits the target profile.
My wife just received control of a dynasty trust, another type of trust to minimize estate tax as well as avoid generation skipping tax. The grantor is her father. Trying to figure out whether she can run it by herself and avoid a corporate trustee. Any info of trust tax returns and how to invest in a trust fund would be greatly appreciated. I plan to invest in low cost index funds and muni tax free bond funds as trust tax rates have low threshold to get to the upper brackets.
What does the trust document say? Chances are good that there is another trustee.
The trust will need to file return.
The investing, however, can be done pretty easily. But keep in mind your wife probably doesn’t get to determine that, much less you. But read the trust document to see.
She should go over the trust with an expert trusts and estates attorney. There may be things she cannot do, may be required to do, or that are important to consider as she serves as trustee. Who are the beneficiaries now and in the future? Is she expected to make annual distributions? Are there minimum amounts? Who will be trustee after her?
How she invests may depend on the answers. If she anticipates no need to distribute funds for a long time, say 20 years, then she could be quite aggressive. If one or more beneficiaries will need significant parts of the total each year, then she may have to be more conservative. If the trust is truly intended to last for many generations, then she could put some in illiquid long term investments.
The attorney should also be a tax expert. Basically, something like VTI plus munis will generate low taxes. But there are other considerations when the horizon is decades to centuries.
If looking at SLATs, also make sure to look at a GRAT. Depending on your age, and the age/maturity of your heirs, could be another good option to deal with the estate tax.
Yes, should be considered.
What happens when assets go into the irrevocable trusts? For instance if you have property or a business within it, since no longer in your control, can you still sell them or get a loan against them, etc or is now just whatever they designated trustee does?
The trust can sell them. The trust can get a loan against them. The trustee makes the decisions. In our particular case, we’re the investment trustees. So we can do all that. But we’re not the distribution trustee. If we want a distribution, the distribution trustee has to approve it.
What I want to know is, how do you find, screen, and select an attorney for your estate planning? I feel like it’s pretty tough to narrow it down with Google.
What kinds of questions should I be asking when trying to find an attorney for this task? I’m always concerned that I’m going to get nickle/dimed for any email or individual question I might have.
Also, any specific recommendations for reading about estate planning? The more I read, the more I realize I know very little about it. I want to learn more about the intricacies of things like revocable and irrevocable trusts (of different varieties) so I can come in with a plan for what I want accomplished. But I also know there are lot of things I’ve never even heard of (like SLATS, prior to this post) that I’d like to be informed on in case it gets recommended, so I can make educated decisions. Thanks.
It’s not considered the most difficult law to practice, so I’d just look for experience. I would think 10 years doing it full time would be enough.
If you don’t want to be nickel and dimed, get someone that just charges one big flat fee. Not sure you come out ahead, but all your little email questions don’t cost you any more.
I write about it from time to time and have covered the basics pretty well I think. For more complicated techniques, they’re usually googleable. The answer is usually an article posted on an estate attorney’s website/blog that they use to try to attract clients.
Can you comment about using revocable trusts vs slat. We have met with a few and conflicting opinions given on which to use thanks
What are you trying to accomplish? Those two things do very different things. A SLAT provides much more asset protection and potentially much lower estate tax bill. A revocable trust allows for a lot of control and flexibility but still avoids probate. But it provides zero asset protection and doesn’t lower the estate tax bill at all if you’re facing one. Personally, we have both.