The challenge for people like you, who want to accumulate and pass your assets to your spouse and children is determining the best possible strategy. What is the most effective way to protect your assets from potentially crippling income, gift, and estate taxes while providing? How can you provide an income source for your spouse? Without a tax-savvy strategy and the right trust arrangement, your heirs could see these taxes devour up to half, or even more than half, of their inheritance and your spouse could find it difficult to access cash funds in a hurry.
A highly effective way to address these concerns is through a Spousal Lifetime Access Trust or SLAT. This estate planning arrangement provides a creative way to access life insurance policy cash values while having the death benefit excluded from the estate.
How a SLAT Works
1. The person being insured (the grantor) establishes an irrevocable Life Insurance Trust (ILIT). The trust beneficiaries are the spouse and the grantor’s children/grandchildren. The trust is the policy owner.
2. The spouse is named trustee of the trust. (Other family members can also serve as trustee.)
3. The trust purchases a policy on the insured/grantor, which is funded with gifts from the grantor. The gifts must come from the grantor’s separate property, not from jointly help property.
4. During the grantor’s lifetime, the spouse can take loans, withdrawals, and distributions limitations such as health, maintenance, education and support.* The loans and withdrawals may reduce the policy’s death benefit.
5. When the grantor dies, the policy’s death benefit will be paid to the trust and will pass to the spouse and children/grandchildren free from income** and estate tax.
Benefits Provided by a SLAT
- Potential cash value accumulation through the life insurance policy
- Income tax benefits
- Insurance policy proceeds are kept out of the estate
- Protection from potential creditors, professional liabilities or other unforeseen losses (depending on the state law)
- Allows access to policy cash values that can be tax-free if the policy is properly structured
- Upon the death of the grantor, the policy death benefit passes to the heirs without incurring income or estate taxes
Possible Drawbacks
§ Access to policy cash values aver available only for the non-insured spouse. Divorce or death of the non-insured spouse can reduce the benefits of this planning technique.
§ The trust needs to be carefully drafted and funded to avoid inadvertent inclusion in the estate.
§ Trust distributions should not be used by the insured/grantor or commingled in the insured’s accounts. This could result in inclusion in the estate.
* Tax-free distributions assume that the life insurance policy is properly structured, is not a modified endowment contract (MEC), and distributions made are withdrawals up to the cost basis and policy loans thereafter. If the policy lapses or is surrendered prior to the death of the insured, there may be tax consequences.
** Proceeds from a life insurance policy paid because of the death pf the insured are generally excludable from the beneficiary’s gross income for federal income tax purposes.
