SLAT Trusts: Risky or Rewarding? 7 Things To Be Aware Of

Elderly couple signing documents to create a SLAT trust with a qualified financial adviser

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Are you considering setting up a trust for your assets, but are unsure if a SLAT trust is the right choice for you? You’re not alone. Throughout the last decade in particular, many individuals who have been looking to protect their wealth and plan for the future have turned to SLAT trusts — but if you are thinking about this option, it’s important to be aware of their potential risks and rewards. It can be a pretty complicated arrangement if you’re new to it, and it’s time-sensitive, too…

The big question on every estate planner’s mind right now is: “Will the federal tax exemption limit be reduced?” The lifetime gift and tax exemption limits are currently at an all-time high and have been increasing every year since 2017, but unless things change in Congress, they’re due to drop massively to pre-2017 levels. This is why it’s important that you start thinking about options like SLAT trusts now, in order to take advantage of this rare opportunity (especially with an election coming up in 2024).

In this comprehensive guide, we’ll take a closer look at SLAT trusts and cover 7 essential ideas and explanations to help you determine if they are the best fit for your financial goals. By the end of this article, you’ll have a better understanding of what a SLAT trust is, how it works, and whether or not it’s worth adopting as part of your estate planning needs.

1. What is a SLAT Trust?

Simply put, SLAT trusts (Spousal Lifetime Access Trusts) are a legal arrangement for married couples whereby:

  • One spouse (the “grantor”) irrevocably transfers their assets out of their estate and into a trust (thereby removing the grantor’s estate tax liability upon his or her death);
  • The grantor sets the terms of the trust and appoints a trustee to manage it (either their spouse as a “beneficiary trustee” or an independent, third-party trustee); and
  • The other spouse (the “beneficiary”) is given lifetime access to these assets via distributions from the trust.
 

For high-net-worth couples, this arrangement is enticing as an option for estate tax planning purposes, as the transfer of assets into the trust can significantly reduce the grantor’s estate tax liability, up to the gift and estate tax exemption limits set by the federal government. It also offers meaningful creditor protection to the beneficiary spouse.

Assets can include anything from:

  • Cash;
  • Life insurance;
  • Real estate;
  • Businesses;
  • Stocks and bonds;
  • And more.
 

You should bear in mind, however, that the assets transferred must be owned by the grantor only; jointly owned assets cannot be transferred into a SLAT trust.

2. How Does a SLAT Trust Work?

SLAT Trusts Part I: Within the Beneficiary Spouse’s Lifetime

As we mentioned, a SLAT trust is an irrevocable trust. This means that once the assets are transferred, the grantor loses access to and control over those assets permanently. However, the beneficiary spouse can still access the trust during their lifetime, which means the grantor can indirectly benefit from the trust assets through their spouse, while enjoying the estate tax exemption that comes with the trust.

That said, the beneficiary spouse needs to be careful in how they manage distributions from the SLAT trust, especially where they have been appointed as its trustee (“a beneficiary trustee”). In this instance, the beneficiary spouse should only make distributions for:

  1. Health;
  2. Education;
  3. Maintenance; or
  4. Support.
 

If the beneficiary trustee decides to make distributions beyond these categories, the trust assets become taxable as part of the grantor’s estate once more — defeating the very purpose of the trust.

One way around this is to insert a legal clause into the trust known as the “5 or 5 power”: this allows the beneficiary of the trust to withdraw whichever is higher out of $5,000 per year or 5% of total trust assets, in addition to the above four categories. Another way around this is to make sure that you appoint a third-party trustee to the trust (i.e. not the beneficiary), as this person also has discretion to make distributions beyond these four areas.

SLAT Trusts Part II: After the Beneficiary Spouse’s Passing

Typically, upon the beneficiary spouse’s death, the assets pass onto the “remainder beneficiaries,” who can also access the trust estate tax-free, as the beneficiary spouse did while they were alive. The couple’s children or grandchildren are usually designated as the remainder beneficiaries.

This part of the SLAT trust timeline sets up the possibility, with proper planning, that you can avoid what is known as “generation-skipping transfer tax” — but it’s worth acknowledging that SLAT trusts face higher scrutiny from the IRS than dynasty trusts, so those are also worth considering if simplicity is your primary concern.

3. What Are the Potential Risks of a SLAT Trust?

Charts representing risks attached to SLAT trust vehicles

As with any financial decision, there are potential risks involved in setting up this kind of trust. SLAT trusts require a high degree of relational trust on the part of the grantor toward the beneficiary spouse, as they must give up all control over and direct access to the assets granted.

The fact that the grantor must relinquish control of their assets also becomes especially pertinent in two key instances:

  1. Death of the beneficiary spouse; and
  2. Divorce from the beneficiary spouse.
 

In the first case, the trust assets would automatically pass on to the “remainder beneficiaries” (see more on this in the previous section), and the grantor would lose the indirect access to the trust they enjoyed through the beneficiary spouse. If this happens at an unexpected time, it will likely conflict with the grantor’s original intentions in creating the trust (i.e. that it would be for their spouse’s benefit and their own, indirect interest in maintaining a shared standard of living).

In the second case, the beneficiary spouse could continue to enjoy access to the trust’s assets even after the divorce, unless the grantor included clauses that accounted for this scenario (e.g. the grantor could specify that the SLAT trust was for the benefit of their current spouse and any future spouse only, thereby removing the possibility that the hypothetical divorced beneficiary spouse could benefit from the trust).

All of which is to say that SLAT trusts may not make as much sense for couples where (1) the beneficiary spouse’s health is in a precarious position; or (2) either spouse has questions marks over the stability of the marriage union.

4. What Are the Potential Rewards of a SLAT Trust?

Person offering gift-wrapped box to represent the rewards associated with SLAT Trusts.

Despite the risks, there are many potential rewards of setting up a SLAT trust. As a result of the Tax Cuts and Jobs Act of 2017, US citizens can gift very large amounts to potential beneficiaries without incurring estate tax. In 2024, the IRS has set the gift and estate tax-exempt lifetime limits at $13.61 million per individual or $27.22 million per married couple.

Given that these figures are set to drop on January 1st, 2026, back down to around $7 million per individual and $14 million per couple (unless Congress enacts legislation before then that makes these tax exemption limits permanent), this is a very significant tax-saving opportunity…

…which is where SLAT trusts come in as the vehicle for enjoying this exemption. Any assets the grantor places in the SLAT trust up to the threshold of $13.61 million, as well as any future appreciation and income from the assets in the trust, will be estate-tax free (although note that any amounts placed in the SLAT trust over the threshold will be liable for estate tax).

Some other rewards related to SLAT trusts include protection from creditors for your designated beneficiary (as the trust owns all of the assets, not your beneficiary spouse) and the grantor’s ability, through the trust, to express their wishes regarding how their assets are to be distributed after their death (instead of or in addition to wills and other probate documents).

5. Is This Type of Trust Right For Me?

Summarising the two sections above, determining whether a SLAT trust is the right fit for you will depend on your specific financial goals, specific marriage relationship and specific period of life.

If you have significant assets that you:

  1. Want to shield from estate tax;
  2. Want to retain some degree of control over through the written provisions of the SLAT trust;
  3. Trust your beneficiary spouse to faithfully steward the assets placed in the trust for their benefit and yours (indirectly);
  4. Want to pass your assets down to your heirs in a tax-efficient manner after your beneficiary spouse’s passing; and
  5. You and your spouse understand and are happy to abide by the (potentially intricate) nature of this arrangement…
 

…then a SLAT trust may well be worth considering, and considering quickly (given the time limit imposed by the federal government). If you want to get a SLAT trust up and running before the deadline, you should consider consulting with a trusted financial advisor like Iron Point Financial to help you make the best decision for your needs.

6. What Are Some Additional Considerations When Setting Up a SLAT Trust?

Before setting up a SLAT trust, there are three additional, important factors for you to keep in mind that relate to a) annual income tax; b) capital gains tax; and c) the “reciprocal trust doctrine”.

SLAT Trusts: Annual Income Tax Implications

If you are wondering about some of the non-estate-tax implications of SLAT trusts, the first thing to note is that the trust grantor must still pay taxes on income generated by the trust assets (for example dividends from shares, interest from bonds, and capital gains).

So the question that you as the grantor need to answer before setting up a SLAT trust is: “Will I comfortably be able to cover the cost of the annual income tax generated by the trust assets?” That said, if you are happy and able to cover this income tax burden, it can actually work in your favor: by paying income tax on the assets in the SLAT trust, you are essentially decreasing the size of your taxable estate even further!

Plus, by paying income tax on any appreciation in value of the trust assets, you will be successfully shielding your beneficiary spouse from paying income tax on those same assets. So, in a manner of speaking, the arrangement is a clever way to help you split your tax burden (especially where your beneficiary spouse relies solely on the SLAT trust assets for their income — that would theoretically minimize their income tax burden).

SLAT Trusts: Capital Gains Tax

When you gift assets to a SLAT trust, they do not receive a “step up in cost basis” at the time of your death, meaning that any future increase in the gifts’ value may incur capital gains taxes for your heirs. Even so, capital gains tax of this kind would likely be much less than the estate taxes your beneficiaries would have to pay if the assets existed outside of the trust, so this is a relatively minor consideration.

One thing you can do to compensate for this lack of step up basis, however, is to include a clause in the SLAT trust constitution that enables you, as the grantor spouse, to exchange property in the trust. This means you could swap out low-basis property for high-basis property and thereby lessen your heirs’ capital gains tax bill.

SLAT Trusts: “Reciprocal Trust Doctrine”

You might have read the “rewards” section of this guide and wondered, “Why not just set up two SLAT trusts? One for me, and one for my spouse?” If this thought entered your mind, beware! Although you could technically set up two SLAT trusts (one granted by each spouse for the other), this could fall foul of what is known as the “reciprocal trust doctrine.”

The reciprocal doctrine is where the IRS deems that the two entities (e.g. SLAT trusts) are similar enough that they cancel one another out — and if the IRS makes this judgment about your trust, your assets will be liable for hefty estate tax charges once more.

Nevertheless, there have been successful instances of couples setting up two SLAT trusts, where they have been very careful to create them:

  • At different times;
  • With different trust language and provisions;
  • With different named beneficiaries; and
  • With different distribution uses.
 

It should be noted that to be successful with this kind of estate planning strategy, you would be well-advised to seek considerable, water-tight advice from a host of legal, tax and financial professionals.

7. How Can I Get Started?

If you’ve decided that a SLAT trust aligns with your estate planning goals, it’s essential to work with a qualified professional to set it up properly. As we said at the beginning, SLAT trusts can be quite complex to set up and manage in a way that ensures your intentions are properly expressed, and that succeeds in protecting you from undue tax liability. An experienced attorney or qualified financial advisor can help you navigate the legal and tax implications of establishing a SLAT trust.

Closing Thoughts

While SLAT trusts do come with potential risks, they can also offer enormous rewards for those looking to protect their assets and plan for the future. By understanding these SLAT trust essentials, you can make an informed decision on whether or not this type of trust is right for you. 

As always, it’s important to consult with the right experts and to carefully consider your individual financial needs before making any big decisions about your estate planning. 

So, take the time (but not too much time!) to educate yourself on your options, and make the best choice for you and your loved ones.  If you keep these key explanations and ideas in mind, you could be well on your way to securing a sound financial future through a SLAT trust.

And if you have decided that SLAT trusts aren’t for you but you are still interested in other areas of personal finance such as Retirement Planning or Estate Planning, then rest assured Iron Point Financial’s team will be on hand to help you with those, too.

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Iron Point Financial is here to empower you to secure a brighter tomorrow. We operate physical offices in Grove City, PA and Greenville, PA. 

We primarily serve residents of Pennsylvania, Ohio, West Virginia and Florida but we also have registered broker licenses for 22 other states across the continental USA.

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Disclosures

  • For a comprehensive review of your personal situation, always consult with a tax or legal advisor.
  • Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice. 
  • The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional before implementing such strategies.
 
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