Blended Families and the Use of Spousal Lifetime Access Trusts

Because blended or non-traditional families are now the majority in the US, special considerations and risks must be taken into account when using a common estate planning tool like spousal lifetime access trusts (SLATs).

Spousal lifetime access trusts (SLATs) are a common estate planning tool but raise nettlesome issues ... [+] for blended families.getty
Spousal lifetime access trusts (SLATs) are a common estate planning tool but can raise issues for blended families. While SLATs can be a helpful way to manage assets and ensure that loved ones are taken care of after death, they can also create challenges for families who are not married or who have children from previous relationships.

SLATs, or state and local tax deductions, have been a popular way for taxpayers to reduce their tax liability for many years.

It's no secret that the estate tax is a contentious issue, with Democrats and Republicans sparring over its fate for years. However, the recent wave of planning utilizing irrevocable trusts is a sign that people are taking matters into their own hands, regardless of what happens on the political front. For those unfamiliar, an irrevocable trust is set up in such a way that the person establishing it cannot later change their mind and revoke it. This is often done for estate planning purposes, as it allows the person to lock in the current estate tax exemption amount – which, as of 2021, is a whopping $12.06 million. While this figure is adjusted for inflation each year, it is also scheduled to be cut in half come 2026. This has led many people – especially those who are married – to rush to establish these trusts before the deadline, in order to avoid a hefty estate tax bill down the line. So, what does this all mean for the future of the estate tax? Only time will tell. But in the meantime, it seems that more and more people are taking matters into their own hands to ensure that they won't be hit with a huge tax bill down the road.

There are a lot of blended families out there, and they're only getting more common. That means more risks when it comes to SLATs.

It is clear that blended families have a lot to consider when it comes to setting up a SLAT plan. With a higher divorce rate and more complex family dynamics, it is important to carefully consider all of the risks and potential challenges that may arise. With careful planning and a clear understanding of the family's needs, a SLAT plan can be a great way to provide financial stability and security for all involved.

As we mentioned before, one more piece of background is needed before we can fully understand the situation.

It is often said that husband and wife are like two sides of a coin.

There is a legal doctrine, called the "reciprocal trust doctrine," that could be important to consider in planning any SLAT. This doctrine suggests that if the trusts are too similar (and there is not much clarity on what that means) that the trusts could be "uncrossed." That means that the trust husband set up for wife might be treated as his trust and vice versa. That would unravel hoped for tax or assets protection benefits (creditors, not just the IRS, can assert this doctrine to pierce the irrevocable trusts used in the plan). So, lawyers drafting SLATs will incorporate different provisions in each spouse's trust in an effort to differentiate one trust from the other. But as with so many tax concepts the law is murky. There is no clearly defined guidance as to what is sufficient to make a trust non-reciprocal from another trust and the powers and rights you use to differentiate the trusts have real significance. If the differences are done pursuant to a plan to differentiate the trusts might that itself support a challenge that the trusts are too similar? Uncertain. There are many different views on this issue by different tax experts, but that is beyond this article.

There are many ways to make SLATs (standardized linear accelerator targets) different from each other. One way is to change the material of the target, such as using different metals or alloys.

There is no one-size-fits-all solution when it comes to estate planning, and many estate planners have their own favorite list of differences to bake into each trust to try to deflect a reciprocal trust challenge. But there are lots of recipes and no assurance how well the SLAT cake will fare if challenged. Difference might include: trusts that are irrevocable or have different terms than the other spouse's trust, trusts that are not funded equally, or trusts that have different beneficiaries.

New trustees bring fresh perspectives to the table and can help an organization move in new and exciting directions.

There are different state laws governing trusts, with some trusts being situated in Delaware and others in South Dakota. It is important to have a clear understanding of the laws in each state in order to ensure that the trust is properly managed.

The different powers of appointment can be a great way to change the trust or to appoint trust assets to a designated class or group of people. This can be a great way to help people who are in need or to help the trust grow in value.

There are different distribution standards for trusts, which can make it difficult to know what rights are available when making distributions. However, it is important to know what restrictions are in place so that you can make informed decisions about how to distribute your assets.

Now that you mention it, I can see how that would make sense in some cases. For example, if someone wanted to leave their estate to their spouse but not their children, they could do that by adding their spouse to their trust but not their children.

There are many benefits to using different lawyers to create each trust. This approach can help ensure that each trust is properly structured and that all of the necessary legal documents are in place.

It's important to have time pass between each trust so that people can have a chance to process what happened and build up trust again. This is essential for any healthy relationship.

There is no easy answer when it comes to the question of how many units of difference need to be between each SLAT in order for them to not be reciprocal. While there is some case law and rulings on the matter, they are generally older and limited in scope. This means that it may ultimately come down to a judgement call for the attorney or attorneys drafting the trusts. However, it is important to keep in mind that the differences many attorneys build into these trusts can have a significant impact on blended families in particular.

There are many reasons why SLAT differences matter when it comes to choosing the right college or university.

When it comes to trusts, it's important to remember that the various provisions integrated into each one can have significant economic consequences. This is especially true in a blended family situation, where there may be greater potential for divorce and more stress in the marriage. The different children or beneficiaries named in each trust can also have a real impact on the financial security of each spouse. With all of these factors to consider, it's essential to have a detailed discussion with your financial advisor to make sure that your trust is set up in the way that best meets your needs.

As we continue our exploration of the differences between SLATs and other types of programs, it is important to take a deeper dive into the specific areas that make them unique.

The illustrations below make it clear that there can be significant economic consequences to having a non-reciprocal trust plan. However, this is precisely the point – these differences may be what makes the plan sustainable against attacks by the IRS or creditors (although neither of these hoped for results are assured). So, the more substantive economic differences between the trusts, especially in a blended family, the greater the risk that one spouse may subvert the entire plan.

The 5 and 5 Power is a commonly used right or power in trust drafting. This gives a person the right to withdraw the greater of 5% of the trust corpus or $5,000, each year. This right is based on tax laws that would cause any power that is a hair broader to cause all the trust assets over which a person holds a greater power to be included in the powerholder’s estate. Another way to say it is that withdrawing not more than 5% of a trust’s assets annually is the greatest power you can give someone and keep those assets outside the powerholder’s estate. So, if husband’s trust that he created for wife does not have that power, but wife’s trust she created for husband does have that power, that might be a meaningful difference between the two trusts. That means wife would not have the right to pull out 5% of the assets from the trust she is beneficiary of. But husband could pull out 5% of the assets from the trust he is beneficiary of every year. Say the trust hubby can access has $10 million. He can withdraw, no questions asked by anyone, 5% of that, or $500,000 a year, every year, year in and year out. That is unbalanced, but that is the point. That is a difference that has real economic consequences. What if there is stress in the marriage (seemingly likely in a blended family based on the stats), or the marriage even gets rocky? Hubby keeps pulling out $500,000 every year and wife gets to pull out nothing. See the potential issue in every family but especially in a blended family? Let’s expand this example a tad.

The power of appointment is a critical tool in estate planning, but it is important to understand its limitations. In particular, the power of appointment can only be given to someone who is not also the trustee or beneficiary of the trust. Otherwise, the assets would be included in the powerholder's estate. Additionally, the power of appointment must be expressly granted in the trust document. Otherwise, it may be interpreted as a general power of appointment, which would allow the powerholder to appoint the assets to anyone, including themselves.

It is important to remember that when creating a SLAT, there can be different phases with different trust provisions governing each phase. For example, there might be trust provisions during the grantor's lifetime that provide for specified distribution standards to the named beneficiaries. This is known as a lifetime trust. The grantor is the person who sets up the trust and puts assets into it. During that period of time, the trust may be treated as a "grantor trust" for income tax purposes. After the grantor dies, if the spouse is still alive, assets may pass to a family trust for the benefit of the spouse and all descendants. That trust will also have specified beneficiaries and distribution standards. On the death of the last spouse, the assets may pass in further trust to children or other named beneficiaries. To differentiate the trusts, the wife might be named a beneficiary of the family trust after the husband's death. But in the trust wife creates for the husband and beneficiaries, the husband might not be named as a beneficiary of the family trust or the lifetime trust. Having significant differences in who is a beneficiary of the lifetime or family trust, or material differences in distribution standards for each spouse under each trust, might be ways that the trusts are differentiated. But all that has real economic teeth. For example, if the husband is not a beneficiary of the family trust formed under the wife's SLAT, that could be a real economic hardship on him and force him to spend down assets in his own name, thereby reducing or even eliminating what his children from a prior marriage might receive on his passing. That might make one set of the children rather unhappy. Again, the steps taken to differentiate trusts from the reciprocal trust doctrine are not just window dressing, they can have real and substantial financial impact.

The use of a HEMS distribution standard can be a useful tool in protecting assets in an irrevocable trust from creditors and estate taxes. However, it is important to consult with a qualified attorney to ensure that the trust meets all legal requirements.

Independent counsel is important for SLATs to be successful. This is because it helps to ensure that the trust is non-reciprocal. However, this can add to the cost and discomfort associated with the trust. In an intact family, there may be no children from a prior marriage to worry about, so the couple may be less worried about using independent law firms. However, for a blended family, each spouse in the second or third marriage may not know how they are being provided for or their children. This can cause problems down the road.

The use of non-fiduciary positions and powerholders can have a range of different impacts on modern complex trusts. For example, if someone is given the power to loan trust assets to the settlor in a non-fiduciary capacity, this could potentially allow the settlor spouse to access trust assets indirectly. However, if the settlor spouse dies prematurely, the husband's access to trust assets would terminate. Therefore, it is important to consider the possible implications of such provisions before including them in a trust.

The "floating spouse" concept in trusts is an interesting one, but it comes with its own risks. If a trust grantor were to divorce and remarry, their new spouse would gain access to the trust, potentially depriving their current spouse of benefits. This could lead to problems down the road, especially in second or third marriages where the risk of divorce is much higher.

Looking back on this paragraph, we can see that it was leading up to a conclusion.

As more and more families adopt non-traditional structures, it is important to be aware of the potential pitfalls that can arise when using estate planning tools like SLATs. While these tools can offer significant tax and asset protection benefits, they may also create problems for blended families and other non-traditional families if they are not used properly. With careful planning, however, it is possible to avoid these issues and make the most of these powerful estate planning tools.