By Daniel Baumgartner & Petra Peters
Taxes are an undeniable part of life, pervading almost every financial aspect, from the income we earn, the purchases we make, to the investment and properties we own. We encounter taxes in various forms, such as income tax, sales tax, property tax…even when we travel, we pay hotel or tourism taxes. But perhaps one of the least discussed and most significant tax implications is what happens at the end of life—the “death taxes.”
Death does not absolve us (or, rather, our estates) from the reach of the taxman. Even after passing away, our financial legacies may be subject to estate taxes depending on federal and state law. These “death taxes” are especially aimed at high-net-worth families, and can have substantial impacts on the wealth we aim to pass on to our heirs, making it all the more important to consider effective estate planning strategies.
Changing Estate Tax Exemption Limits
The right estate planning strategy to lower, or eliminate, any taxes your estate will owe at your passing is especially more important to consider in light of changing legislation. Effective in 2018, the Tax Cuts and Jobs Act (TCJA) significantly impacted estate planning by nearly doubling the federal estate and gift tax exemption. The exemption rose from $5 million to $10 million per person, indexed for inflation, resulting in a $12.92 million exemption per individual and $25.84 million for married couples in 2023.
However, these increased exemption amounts are not permanent and are set to “sunset,” or revert back to the pre-TCJA levels, after December 31, 2025. This means that unless further legislation is enacted, starting in 2026, the exemption will fall back to $5 million per person (adjusted for inflation), which could notably affect estate planning strategies for many individuals and families. If not planned for properly, any assets above these amounts may be subject to estate taxes, which start at 18% and go all the way up to 40%.
Given the political uncertainty of if and how these amounts will change in the future, the best time to plan is right now. Furthermore, there is actually a way to use these higher exemption amounts now, before it reverts back to the lower threshold. One way to do that is through a Spousal Lifetime Access Trust (SLAT).
Basics of SLAT Trusts
In a SLAT, one spouse, known as the donor or grantor, transfers assets into the trust for the benefit of the other spouse, who becomes the beneficiary. A donor can put cash, real estate, investments, life insurance policies, or even business shares into the trust. This allows for a reduction in the estate of the donor spouse, thereby minimizing potential estate taxes, while still allowing the couple to indirectly access the assets through distributions to the beneficiary spouse.
The assets within a SLAT, and any growth they accrue, are removed from the donor spouse’s taxable estate and remain outside the beneficiary spouse’s estate as well. Upon the death of the beneficiary spouse, the remaining trust assets are distributed to the remaining beneficiaries, typically children or grandchildren, in accordance with the trust terms.
Each spouse can use a SLAT for the benefit of their spouse. By doing so, they would essentially exclude $24.12 million from their estate, have access to ongoing distributions from the SLAT, as well as any assets they did not put in the trust.
Benefits of SLAT Trust
First and foremost, a SLAT facilitates significant estate tax savings. By transferring assets into the trust, the grantor reduces the size of their taxable estate, thereby potentially minimizing estate taxes upon their death. Meanwhile, the assets and their future appreciation are excluded from the beneficiary spouse’s taxable estate as well.
Even though the assets have been transferred into the trust, the couple can still indirectly benefit from them through distributions of income or principal made to the beneficiary spouse.
Furthermore, a SLAT can be set up as a grantor trust, meaning the trust’s income would be taxed to the grantor, reducing their estate even further. If the trust is set up this way, it would also mean that no separate trust tax return would be required while the grantor is still alive.
Lastly, SLATs also provide a level of protection against creditors, as the assets in the trust are generally not accessible to satisfy the grantor’s debts.
Downsides to Consider
Despite its benefits, a SLAT also has certain downsides that must be carefully considered. Since a SLAT is an irrevocable trust, the decision to transfer assets into the trust is final and cannot be undone. This lack of flexibility can be a drawback, particularly in situations where the financial circumstances of the grantor spouse change.
Also, if the beneficiary spouse predeceases the grantor spouse, or if the couple divorces, the grantor spouse loses any indirect access to the assets in the SLAT. If the grantor depends, even indirectly, on the distributions of the SLAT, it would be wise to proceed with caution in terms of what assets and how much you contribute.
Additionally, SLATs are most appropriate for high-net-worth individuals with the risk of going over the estate tax exemption amounts. If you might fall under that limit, you can still give to others without setting up a SLAT. You can give to future generations in your family through annual gifts, or direct payments to hospitals and universities, or you can give to charitable organizations with donor-advised funds.
Finally, setting up dual SLATs—one for each spouse—can be complex and could potentially fall foul of the reciprocal trust doctrine if the two trusts are considered too similar, leading to the potential loss of any of these tax benefits. To follow all the proper rules and don’t negate any potential tax benefits, it’s wise to work with financial and estate professionals who are well versed in SLAT trust rules and best practices.
Properly Plan for Your Estate so You Can Pay Less
While Spousal Lifetime Access Trusts present an effective strategy for estate planning, it’s important to recognize that they come with their own set of complexities and potential drawbacks. The decision to use a SLAT should be made with careful consideration of your specific financial and family circumstances, with the help of trusted professionals.
If you’re looking to minimize the amount of taxes you pay throughout your life and even at your passing, we’d love to see if we can help. You can reach out to us directly at 212-355-1234 or firstname.lastname@example.org for the New York office (Petra) or 855-248-6630 or email@example.com for the New Jersey office (Daniel). You may also contact us here to schedule a meeting and we’ll get in touch with you soon!
Daniel Baumgartner is a founding partner of Terra Nova Asset Management LLC, a partner-owned investment advisory firm that manages individual portfolios for clients. Daniel has extensive experience in marketing, development of special U.S.-investment products, as well as customer acquisition and relationship management. His ultimate goal is to make a difference in his clients’ financial lives through honest investment advice. He strives to provide high-touch, personalized service and enjoys getting to know a client’s personality as it relates to their financial circumstances before crafting the right solutions. As money is a very personal subject, Daniel takes his responsibility as an advisor very seriously, forming long-term relationships with clients based on trust.
Daniel received his degree in finance and international business from New York University. Outside of the office, he is a hobby landscape, street photographer, and has a great interest in U.S. and European history (16th-19th centuries), believing it helps him answer the question “Why is something the way it is?”
Petra Peters is a founding partner and the Chief Executive Officer of Terra Nova Asset Management LLC, a partner-owned investment advisory firm that manages individual portfolios for clients. Petra has decades of experience in the banking industry, asset management, overseeing the administration of individual accounts, and designing and advising specialized funds tailored to the requirements of international private and institutional clients. With extensive knowledge of both Europe and the U.S., she’s able to provide advice and services beyond the typical investment advisor. Petra desires for her clients to live a financially care-free life so they can pursue their passions, and she values their trust and gratitude. Creating invaluable friendships formed over years of partnership, some clients even consider her part of their family.
Petra’s interests outside of work include classical music, history, travel, charities, motorcycling, and golf. She is also on the board of a German charity.