Lifetime Spousal Trusts: To Have and To Hold Your Marital Assets

Frequently, married couples have the desire to bequeath all of their assets to each other upon their passing.  However, there may be reasons for spouses to instead transfer assets to each other during their lifetimes. Specifically, they may want to consider transferring assets to each other through the use of trusts. There are a number of benefits to using trusts such as creditor and asset protection, as well as the potential for estate tax savings. There are two main types of lifetime spousal trusts, both with different purposes.  That being said, practitioners should be aware of when each trust should (or should not) be used.

The first type of lifetime spousal trust is a Qualified Terminable Interest Property Trust, or a “Lifetime QTIP Trust.”  This type of trust is often utilized when one spouse owns a majority of the couple’s assets, or perhaps in a second marriage situation.  It allows one spouse, usually the wealthier spouse, to gift an unlimited amount of assets into a trust for the benefit of his or her spouse. This is beneficial in situations whereby one may not want to leave assets to his or her spouse outright and lose control of where those assets ultimately end up. Instead, by holding assets in a Lifetime QTIP Trust, the spouse making the gift can direct what happens to the assets after the beneficiary spouse passes. For example, the spouse making the gift could receive a benefit from those assets until his or her passing, and then choose the ultimate beneficiaries.

A Lifetime QTIP Trust can also be used in order to use a poorer spouse’s estate tax exemption.  Because there is no portability in New York, many couples fail to take advantage of the New York state estate tax exemption upon the first spouse’s passing.  This can be avoided by funding a Lifetime QTIP Trust.  When executing a Lifetime QTIP Trust, the wealthier spouse transfers his or her assets to the trust in an amount equal to the exemption.  In addition to allowing the wealthier spouse to retain control of the remainder interest, it simultaneously preserves the poorer spouse’s estate tax and generation-skipping tax exemptions.

In order for a trust to qualify as a Lifetime QTIP Trust, an election must be made on a duly filed gift tax return.  Additionally, the beneficiary spouse must receive the income interest for his or her lifetime and the trust must be irrevocable.  The beneficiary spouse may also receive the principal, in the event the trust allows such distributions. One downside to a Lifetime QTIP Trust is that the income interest does not terminate upon divorce and therefore, the beneficiary spouse will continue to receive the income interest for the remainder of his or her lifetime, regardless of whether he or she ultimately remarries.

The second type of lifetime spousal trust is a Spousal Limited Access Trust, or a “Lifetime SLAT.”  A Lifetime SLAT is also a trust whereby one would make a gift for the lifetime of his or her spouse. These trusts can give the spouse a limited power of appointment, as well as access to principal during his or her lifetime. A Lifetime SLAT does not have the same requirements as a Lifetime QTIP and therefore income distributions are not required. Additionally, a Lifetime SLAT can be for the benefit of not only the spouse, but other beneficiaries such as children of the spouse making the gift as well.

Converse to the Lifetime QTIP Trust, a Lifetime SLAT is more frequently utilized when spouses have similar wealth and want to take advantage of their estate tax exemptions during their lifetimes.  One situation in which this may arise is for couples who anticipate a growth in the value of their assets. Instead of using each other’s estate tax exemptions as in a Lifetime QTIP Trust, a Lifetime SLAT uses each spouse’s own exemptions. In this case, a spouse would make a gift to a SLAT in order to lower his or her taxable estate. Any growth in those assets would be outside of the spouse’s estate for estate tax purposes on his or her passing. This allows those assets to grow tax-free, while at the same time providing a benefit to a spouse.

Spouses may also want to execute Lifetime SLATs for each other. By doing so, they could each receive income from the Lifetime SLAT that is for the benefit of themselves, so that there is no reduction in income between the two of them. Additionally, unlike a Lifetime QTIP Trust, a Lifetime SLAT can be drafted in such a way so as to take into account the potential for divorce.  A Lifetime SLAT can direct payments to go to the grantor’s current spouse, so that if a grantor remarries, his or her new spouse becomes the new beneficiary of the Lifetime SLAT.

To determine which lifetime spousal trust is appropriate for you or your client, contact Katz, Smith & Chwat, PC to set up an appointment.

Posted in: Estate Planning, Estate & Trust Administration