By Bronwyn L. Martin, MBA, ChFC®, CLU®, CLTC®, CRPC®, CFS®, CMFC®, AEP®, LACP, AIF®, CFS and Martin M. Shenkman, CPA/PFS, MBA, JD, AEP® (Distinguished)
Spousal lifetime access trusts, or “SLATs” have become one of the most favored estate planning tools. The concept, as all planners know, is that each spouse creates a dissimilar trusts in which the other spouse is, in some fashion and at some time, a beneficiary. The trusts should be differentiated to endeavor to negate the application of the reciprocal trust doctrine. There have been many articles focused on the reciprocal trust doctrine and variations of the SLAT technique, drafting suggestions, and more. This article will focus on some of the economic considerations in evaluating a proposed SLAT plan, determining how much may be advisable to gift to SLATs for a couple, and some of the steps that might be taken to secure the couple or family post funding of the SLAT plan.
The same concepts presented below may be useful to practitioners working with clients who have already established SLATs. Some of those SLAT plans, perhaps many, were completed in a rush in 2020-2022 when there were fears of imminent changes in the law and the financial and insurance analysis discussed in this article may not have been done. Even if the SLATs have been completed and funded it is worthwhile to complete the analysis suggested below if it has not been completed in recent years (and especially if it was never completed). Thus, the concepts below while they should ideally be completed at the planning stage of SLATs, they should be completed after the plan has been implemented and every few years or if there have been material changes in the family’s circumstances.
Case Study For SLAT Update Analysis
To illustrate the financial implications of a SLAT, plan the following case study will be used.
- Assume that the hypothetical couple both age 65, have a $16 million net worth and plan to gift $5 million into each of two non-reciprocal SLATs for a total initial wealth transfer of $10 million. The couple’s retained assets include their home valued at $1 million and $5 million of investment assets.
- What does this plan look like when the couple’s financial status if forecasted out to their ages 95 or 100 (or whatever age the planning team determines appropriate)? This step may be important to demonstrate to the couple the long-term consequences of the plan.
- This could be particularly informative to evaluate in the context of one spouse dying at an early age, and the surviving spouse living to age 95 or 100. Will the surviving spouse have adequate resources to provide for his or her lifestyle expenses? The results will depend on what access the surviving spouse has to each SLAT. This includes the SLAT the deceased spouse created for the surviving spouse, as well as the SLAT that the surviving spouse created for the deceased spouse. In some plans, the latter is the key issue as there may be little or no access to the SLAT that the surviving spouse created. That analysis will vary substantially if the trust each spouse creates has as hybrid domestic asset protection mechanism (i.e., the settlor spouse can be added back as a beneficiary) or if the SLATs include perhaps a special power of appointment (the so-called “SPAT” variation) in which a person in a non-fiduciary capacity can direct the trustee to distribute trust corpus to the settlor spouse. For this analysis assume these more advanced techniques were not employed (perhaps because the jurisdiction in which the trusts were created were not self-settled trust jurisdictions, or perhaps the client felt that the incremental risk of a DAPT, hybrid DAPT or SPAT were too great). Thus, the discussion following will presume more “standard” SLATs that do not include these additional means of access.
- Evaluate what the implications would be if the clients decide to purchase a $2 million vacation home so $6M of their retained assets are comprised of non-income producing homes that require carry charges. What does this do to the plan? For a couple with a net worth of $16 million it may not be a financial stretch to own a $1 million home and then purchase a $2 million vacation home. $3 million out of $16 million invested in non-income producing, cost generating (property taxes, maintenance, insurance etc.), personal residential property might be sustainable. But what is the impact of that financial move in the context of a SLAT plan? This may be sustainable in the SLAT plan but if one spouse dies prematurely and the second spouse has limited or no access to the trust for which they were settlor, the financial strain created by the additional carrying costs and loss of investment income over years of time may create a hardship for the surviving spouse even if this is sustainable had no SLAT planning been done.
- What is the impact of investment fluctuations on the plan? Assume the country enters a recession that is deeper then some commentators have predicted and there is a 20% decline in the value of the investment assets of the client due to the market fluctuations. Assume further that there is a commensurate decline in the investment income/cash flow the clients realize. What does the same SLAT/financial plan look like now?
Practitioners should collaborate so that someone on the planning team evaluates reasonable or likely “what-if” financial scenarios to stress test the plan. Even if no change is made to the SLAT plan, at least the clients will have a better understanding of the financial implications of a proposed estate plan. Based on the modeling the clients may request their estate planner to create the one or both trusts in DAPT jurisdictions and to add a DAPT, hybrid DAPT or SPAT provision to one of the SLATs. It may be advantageous if there is financial concern to have each SLAT have situs in a different DAPT jurisdiction and use a different mechanism in each trust. For example, if more access is needed the first spouse could create a hybrid-DAPT in Delaware and the second spouse might create a SPAT in South Dakota. This approach may provide further differentiation for purposes of the reciprocal trust doctrine, and the addition of the hybrid-DAPT and SPAT “spigots” may provide financial security in light of the financial modeling completed. Whatever ultimate decisions are made by the client, the process of illustrating possible “what-if” scenarios will assure that the clients better understand the implications of the plan and can better weigh the pros/cons of various options. Perhaps a client that initially rejected using a hybrid DAPT as to complicated and costly may reconsider that decision when viewing the financial implications of a market downturn and premature death of their spouse.
If the SLAT plan has already been completed and funded the above analysis is still essential but the options to address potential shortfalls may be more limited as converting a traditional SLAT to a DAPT in which the settlor spouse is a beneficiary may not be feasible (although in some instances powers of appointment included in the initial SLAT document may provide some flexibility).
The planning team, including the estate planning attorney (situs, drafting techniques, access mechanism), accountant (impact of tax burn of grantor trust status), insurance consultant (options to use insurance to fill various financial gaps in the plan), and financial adviser (realistic lifestyle budget and forecasting various scenarios) should collaboratively evaluate what access the clients have to assets in the SLAT plan.
Some advisers recommend not touching assets for 3-5 years after funding to reduce the risk of a fraudulent conveyance or implied agreement challenge succeeding. The longer that assets in the SLATs remain untouched by the settlor spouse perhaps the stronger the argument that there was no implied agreement between the settlor spouse and trustee. That may be a more nettlesome question when a family member serves as trustee rather than an independent person or professional trustee.
What access does each spouse have to the SLAT they created as settlor (i.e., the other spouse’s SLAT)?
- Who is named beneficiary? If the donee spouse is named beneficiary does the trust provide that that donee spouse is a primary beneficiary? Does the SLAT provide that the done spouse’s needs be given priority over the needs of the other beneficiaries (children, descendants, and perhaps other relatives)? What is the relationship and financial status of those other beneficiaries? Is there a deferral period before the donee spouse can become a beneficiary? Some SLAT plans provide that the donee spouse cannot be a beneficiary for some time period e.g., 5 years from the formation of the SLAT. Some practitioners might add a deferral in one SLAT and not the other SLAT to differentiate the economic implications of the SLAT plan to endeavor to negate the risks of a reciprocal trust doctrine challenge. The terms of that deferral (or other limiting provisions) must be understood and reflected in the financial forecasts.
- What distribution standards are provided for in each trust and each sub-trust? For example, a simple SLAT may have different provisions applicable to the beneficiary spouse while the settlor spouse is alive (that trust may be referred to as a “Lifetime Trust”), different standards in a trust for the donee spouse and children after the settlor spouse dies (that might be called a “Family Trust” and may be akin to the common credit shelter trust), etc. Distribution standards may be limited to health education maintenance and support, the so-called “HEMS” standard. Distribution standards may permit a distribution pursuant to a broader standard of comfort and welfare of the donee spouse if made by an independent trustee. There could be significant variations in the possible distribution standards and the planning team should understand those nuances when forecasting and modeling the results of the SLAT plan and in particular the access of a particular spouse to either SLAT.
- Who else is a beneficiary? Many SLATs make all descendants beneficiaries so the trustees may have to consider their needs as well. An elderly parent or other loved one may be named as a discretionary beneficiary as well. That might be done to coordinate with the granting of a general power of appointment, or because the settlor has been and will continue to provide support to that person, or both. But all of this must be evaluated from the lens of how the trustee, especially an independent institutional trustee, may evaluate the relative needs of the various beneficiaries.
- Is there a provision that states that the spouse is the primary beneficiary? What language is used and how might the trustee interpret and apply that language? Does the trust suggest or perhaps mandate that other resources or income of the spouse be considered?
- The key point is that the planning team needs to understand what the proposed or existing SLATs provide in terms of access and then discuss with the client the implications. If the SLAT has not been executed, discuss whether any changes might be made to those standards to better accommodate the clients perceived needs for access. All of this should be discussed in the context of whether the differences between the two trusts might be reduced to provide greater access. Discuss with the client whether the client is willing to accept greater risk if there is a challenge to the plan based on the reciprocal trust doctrine, an implied agreement for access with the trustee, or that the clients retained too many rights in the trust and that thereby the assets remain included in the client’s estate, in order to obtain greater access.
- Many SLATs differentiate each trust’s provisions as to spousal access to make the trusts different for reciprocal doctrine purposes. This could have a profound impact on what access each spouse has to each trust’s income and assets and may also affect the insurance plan that might be used to bridge these gaps. So, for example, if the wife is only a beneficiary as to income of the husband’s SLAT, and the husband is a beneficiary as to both income and principal of the wife’s SLAT, a larger insurance policy might be purchased on the husband’s life in his SLAT since the wife may have a greater need for economic protection then the husband does in the event of the premature death of either. This is because of the different distribution provisions in the SLATs that were incorporated into the trust documents to differentiate them for purposes of the reciprocal trust doctrine. There are many variations of these differences and no “standard” approach should ever be presumed. Too often this level of precision of parsing the details of each trust’s actual provisions, is really critical to understanding the plan, is not considered in evaluating and forecasting the implications of the plan. The financial adviser may request that the drafting attorney outline the access each spouse has in a memo, or perhaps review the exact trust provisions and even annotate a draft of the trust highlighting these. Financial advisers should not forecast SLAT plans before understanding these nuances and the implications could be dramatic.
- Perhaps, if insurance is to be purchased on husband’s life to address this economic risk, a new insurance trust (perhaps a simpler less costly home-state trust) might be created that permits both income and principal distributions to wife, which may be broader than the existing SLAT for the wife. While that creates more complexity and cost it may actually serve her needs better since wife may then be able to access all insurance proceeds. The new insurance trust created based on a new financial plan years after the SLATs were created should not face a reciprocal trust doctrine issue (e.g., if the distribution pattern of the new ILIT follows the distribution pattern of the now old SLAT wife created for husband).
- The advisers and clients may never have focused on the real economic implications of the differences between the two SLATs that were integrated to address the reciprocal trust doctrine when the plan was crafted. They may have primarily focused on the avoidance of the reciprocal trust doctrine itself, not the economic implications to each spouse for future financial planning projections, and in particular, in the event of a premature disability (leading to the termination of earned income) or death of either spouse. Understanding and quantifying these implications in a financial model will give the clients a more realistic understanding of the implications of the plan. Interestingly, some commentators have suggested that many SLAT plans will not pass muster when examined under the microscope of the reciprocal trust doctrine. Query whether these naysayers have actually parsed the SLAT provisions and had forecasts done of the possible implications.
- If a professional trustee is used, e.g., a trust company, the clients could be instructed to call the trust company and speak to a trust officer and understand the process of the particular trust company as to how a beneficiary spouse can request a distribution. There will likely be a distribution committee that has to review the request. The client’s should understand that formality. What is the meeting schedule of the distribution committee? If the committee only meets once a month or even less frequently the client must understand that. What information and documentation might the committee request? Some clients operate under the mistaken assumption that if the beneficiary donee spouse requests a distribution a check will be mailed out forthwith. That is not likely to be the case. If the clients invest the time inquiring before the SLATs are completed they may be less likely to be annoyed or worse when the time comes and they request a distribution only to find it is not automatic.
A potentially significant impediment to properly forecasting the potential implications of a SLAT plan, and then revising the plan to reflect the results of that modeling, and evaluating disability, life and long-term care insurance options to fill gaps if any in the plan, is that, as discussed above, this can be a highly tailored analysis that requires time and input from the entire planning team. Many clients if not most, will balk at the cost and time delays the above analysis will require. The issue that raises, is that it should be the client’s burden if the plan does not succeed if the client would not permit the team to complete a tailored and detailed “what-if” analysis of the plan.
Sample SLAT Language
The following is sample SLAT language. The language in any trust an adviser sees will likely be different and the nuances of the exact language used should be considered. Hopefully, these illustrations will provide some insight into the type of language that should be analyzed in evaluating a proposed SLAT plan.
Sample SLAT Lifetime Trust Distribution Husband: “During The Grantor’s Life. During the Grantor’s life, the Trustee shall administer the trust (the “Lifetime Trust”) pursuant to this paragraph: The Trustee may, but shall not be required to, distribute as much of the net income and/or principal of the Lifetime Trust as the Trustee (excluding, however, any Insured Trustee and any Disqualified Trustee) may at any time and from time to time determine to such one or more of the Grantor’s Spouse and the Grantor’s descendants in such amounts or proportions as the Trustee (excluding, however, any Insured Trustee and any Disqualified Trustee) may from time to time select for the recipient’s health, education, maintenance or support in his or her accustomed manner of living…” Sample language courtesy of Interactive Legal Systems.
Sample SLAT Lifetime Trust Distribution Provision Wife’s Trust: “During The Grantor’s Life. During the Grantor’s life, the Trustee shall administer the trust (the “Lifetime Trust”) pursuant to this paragraph: The Trustee may, but shall not be required to, distribute as much of the net income and/or principal of the Lifetime Trust as the Trustee (excluding, however, any Insured Trustee and any Disqualified Trustee) may at any time and from time to time determine to such one or more of the Grantor’s Spouse, the Grantor’s descendants, in such amounts or proportions as the Trustee (excluding, however, any Insured Trustee and any Disqualified Trustee) may from time to time select for the recipient’s [No HEMs]…”
The above language has clear implications to the analysis of access and financial modeling and serves to illustrate some of the points to consider.
Impact of Retirement
Consider the impact of retirement on a SLAT plan. Perhaps when the SLAT plan was implemented the spouses were both in their early 60’s and working and there was no intent to touch any income or principal of either SLAT until both were retired. Now the couple has retired the clients wonder what access they have to each trust and how they can start accessing the SLATs to fund lifestyle expenses in retirement. Each SLAT needs to be carefully reviewed to determine precisely what the dispositive provisions are in each.
How Insurance Can Bridge Some Of The Financial Gaps In The SLAT Plan
- Life insurance on one or both spouses’ lives to address the risk of premature death and a reduction or loss of access to the trust the deceased spouse was primary beneficiary of.
- Disability income replace insurance may help address the risk of losing income by one or both spouses due to a long-term disability.
- Long term care coverage for the clients if after large wealth transfers to the SLATs their finances suggest long term care. Even if not suggested by the financial analysis the clients may feel financially less secure after the transfers to the SLATs so that long-term care coverage.
An example or case study can illustrate some of the points discussed above. The following real-life assumptions in financial situation for the couple:
- $4 million value for their main house. The mortgage is $11,224/mo. (3.2%) and ends in 2036. Property taxes are $30,000/year.
- The new vacation home the couple purchased, as discussed above, had a purchase price of $2 million. The monthly mortgage is $9,662 (with interest at 5%) and ends in 2052. Property taxes are $20,000/year.
- The husband has 401k assets of $1.2 million.
- Non-qualified joint account of $500,000 invested in a moderately conservative asset allocation in terms of risk tolerance.
- They have $100,000 in cash reserve as their rainy-day fund.
- Each of the irrevocable SLATS was funded with $5 million each.
- Excluding the cash reserves, all accounts are earmarked for retirement and the husband is maxing out his 401k with a $27,000 contribution (2022) with a 4% employer match
- The family net worth inclusive of the irrevocable SLATs is a bit over $15 million, at $15,075,223.
- The forecasted net worth was $37,088,298 at assumed ages of death of 95 for both.
- Husband’s salary is $700,000, with a $250,000 bonus for the current year.
Construction of SLAT: Assume that each spouse gifts $5 million in a moderate risk tolerance portfolio to their SLAT. Each SLAT portfolio will be assumed to generate about $100,000 per year. That yield is used to fund a variable universal life insurance policy inside one of the SLATs. This provides a death benefit of $3.6 million, with a premium schedule of 20 years of payments, or $1.976 million total invested into the policy. One spouse can access principal, yield, capital gains, and cash value in this type of a diversified portfolio to pay for long term care needs, i.e., in 15 years. After the grantor spouse’s death, life insurance policy proceeds will be paid into the SLAT, which is designed t o benefit the grantor/settlor’s spouse then distribute the remainder to the children or other descendants, keeping assets in trust for beneficiaries who are minors.
If the value of the investable assets (SLAT and 401k) drops by 20% and the joint nonqualified account by 10% (e.g. May 2022), the net worth drops to about $12,750.135. If that smaller dollar value is projected forward to an assumed death at assumed age 95 of $27,480,175. But despite that decline the couple are still remains reasonable on track for retirement.
If the couple feels they need to adjust expenses due to a bear market/recession/high inflation as experiences in 2022, then they could reduce the death benefit of the life insurance policy inside the SLATs, pay the life insurance premiums over a longer time frame, reduce lifestyle expenses (or a combination of all three steps). The couple could even consider at some future point obtaining a reverse mortgage on their primary residence (age 62 is the typically the minimum age). Pre-bear market, they are on track for the husband to retire at age 67 (assuming that the wife is already retired).
Keep in mind that, historically, a bear market is 13 months in duration followed by a 4-year duration bull market.
What the above analysis may reflect is that despite a significant bear market, the couple may remain on track to meet their financial targets. Also, several options were identified to provide further financial flexibility of the conditions continued to worsen, or even if the couple merely felt too nervous not to react. In this hypothetical a one time drop of 20% in the client’s investment portfolio does not necessarily have to adversely affect lifestyle. The key point is that the process discussed, careful review of exact trust provisions, evaluate “what if” changes to the couples lifestyle and insurance needs, may be useful to assure that the couple’s financial goals remain viable despite a SLAT plan and likely financial developments.