A spousal lifetime access trust (SLAT) is an effective tool for saving money on estate taxes. When a SLAT trust is created, one spouse is the trust grantor, and the other is the beneficiary. The grantor spouse gifts assets to the irrevocable SLAT trust and files a gift tax return for the assets that were gifted to the trust. The beneficiary spouse can access the assets in the SLAT if needed but taking distributions from the SLAT should be avoided and defeats the purpose of creating the SLAT.
How SLATS Reduce Estate Tax
Money that is put into a SLAT will grow outside of your estate and transfer estate tax-free to your heirs. However, SLATS do not qualify for stepped-up basis. Your beneficiaries will inherit your cost basis in the SLAT which means they inherit any unrealized capital gains on the growth in your SLAT. The primary advantage of the SLAT is the savings your beneficiaries can gain by paying long-term capital gains tax rates which are lower than the estate tax which is 40%. Depending upon the state your beneficiaries live in and their federal tax brackets, your beneficiaries might be looking at a 28% tax rate for long-term capital gains taxes when adding federal, state and potentially the net investment income tax. Therefore, your heirs might save around 12% in taxes on the growth of the assets in your SLAT.
- Growth in the SLAT will be estate tax-free.
- Your heirs will inherit your cost basis in the SLAT.
- Expect your heirs to save about 12% in tax on the growth in the SLAT.
- You can reduce capital gains taxes for heirs if you harness gains and pay the taxes with assets outside the SLAT.
Major Financial Planning Update You Need to Make
While you are alive, any taxes owed on investment activity in the SLAT should be paid with the assets outside of the SLAT. When building your financial plan, you should estimate an annual tax burden from the SLAT and add this tax burden to your budget. For example, if you fund a SLAT with $10 million, you might expect around $300k – $400k of dividends and interest, depending upon how the money is invested. You could expect an annual tax bill of $100k or more. You would need to add this ongoing tax burden to your budget and update your financial plan for the increased cash need. This cash need should be paid from your assets outside of the SLAT. Depending upon how much cash flow you need from your assets outside the SLAT for your base living expenses, adding the additional tax burden could result in a new budget that is too high in relation to your assets. A spending rate that is too high could deplete your assets over time. Consult your financial advisor about a safe spending rate.
- Estimate the tax burden from the SLAT.
- Add the SLAT tax burden to your budget.
- Pay the tax burden with assets outside the SLAT.
- Update your financial plan with your new budget.
- Review your spending rate.
Ethan S. Braid, CFA
President
HighPass Asset Management
Denver, CO