Choosing a Spousal Access Trust
Even armed with all of the reasons why it may be more logical to transfer assets during life as opposed to through your estate, it can be difficult to come to grips with letting go of such a significant amount while still facing an unknown future that might include healthcare costs, long-term care, a failed family business, market volatility, and other unforeseeable expenses.
If you understand the value in transferring funds while alive, as opposed to waiting until death, but are concerned about an uncertain future and the possibility of transferring too much, you may wish to consider setting up one or two spousal access trusts.
How Does It Work?
A spousal access trust is an estate planning strategy that allows you to make a transfer during life and still potentially access the funds should there be a need. The strategy involves creating a trust, the beneficiaries of which would be your spouse and descendants.
After setting up the trust, you would transfer up to $12.92 million into the trust account tax free. Depending on your level of comfort, you could start slowly by transferring less than the full exemption amount, or you could transfer the full amount upfront. Following the gift, all income and appreciation on the gifted property (to the extent not distributed to your spouse) would be out of your estate, but you would still have indirect access to the gifted property because your spouse could withdraw trust funds (and place them back in your joint bank account) if necessary.
Here are two examples of possible scenarios for using a spousal access trust:
Creating a trust for your spouse and descendants: During your spouse’s lifetime, the trust could be for her primary benefit, and the trustees would have full discretion to distribute income and principal to her – or if she is adequately cared for, to your children and/or grandchildren. Your spouse could have the annual right to withdraw 5% of the principal of the trust and even have a testamentary power of appointment – that is, the right to appoint at her death the property of the trust to a specified class of persons (for example, “my descendants”).
If your spouse does not exercise the power, when she passes away the property and all appreciation from the date of transfer until her death will pass to or for the benefit of the children and/or grandchildren free of transfer tax.
You and your spouse create trusts for each other: You could also create one trust for your spouse’s benefit, and your spouse could create a similar trust for yours. If you each transfer the full exemption amount, a total of $25.84 million would be transferred out of the estate tax system and excluded from your estates at death. In order for this strategy to be effective, the trusts cannot be identical, because trusts that are interrelated and leave the grantors in approximately the same economic position may be uncrossed for estate tax purposes and includible in each of your estates.
Accordingly, the provisions of a trust created by your spouse would differ slightly from yours. For example, your spouse could create a trust for the benefit of you and your descendants providing that the trustees have full discretion to distribute income and principal among you and your children and/or grandchildren, as opposed to primarily for your benefit. Through this, you could have the right to withdraw income and principal for your support. At your death, you would not have a power of appointment, and the property would simply pass to or for the benefit of children and/or grandchildren.
Note that these provisions are only examples, and the trusts would be designed to fit within your desires and objectives. In order to maintain even more control, you and your spouse may each be a trustee of the other’s trust; however, you would need to also name independent co-trustees.
Access and Use
If you use up your exemption in making transfers to a trust like this, the trust fund should be the last place you and your spouse look for living expenses. Ideally, neither one of you would access the funds during life, allowing the maximum amount of property to pass to your descendants transfer tax free.
And of course, one issue with a spousal access trust is that once you or your spouse passes away, the survivor would no longer have “access” to the trust created for the deceased spouse’s benefit.3 At the death of the spouse, the trust would continue for the benefit of descendants, who could continue to receive distributions in the discretion of the trustee.
While it is extremely rare for parents to transfer more than they can afford, we have seen grateful children take distributions and use the funds to help mom or dad with various expenses. The downside of this approach is that if the expenses are significant, it is basically “reverse” estate planning, where children are transferring assets up to parents as opposed to down to their descendants, something they are generally happy to do where the original funds came from the very parents they are being asked to support.
Benefits of a Spousal Access Trust
Spousal access trusts have several advantages when it comes to tax savings:
- They are structured as “grantor trusts” for income tax purposes. This means that the trust assets would be considered to be owned by you for income tax purposes, and any transactions between you and the trust would be disregarded from an income tax perspective. This means you could swap assets between your personal account and the spousal access trust and could buy and sell assets from and to the trust without realizing gains. Further, you would pay any income tax generated by trust assets, which effectively transfers more money from you to your family outside of the transfer tax system; in effect, you would be making an additional tax-free gift to the beneficiaries in the amount of any income tax you pay on the trust’s behalf.
- They can be “toggled off.” If you begin to feel uncomfortable with the amount of income tax you are paying on behalf of the trust, you may decide to “toggle off” the grantor trust and force the trust to begin paying its own way, another technique for slowing the transfer of assets from you to the next generation.
Many clients are comfortable sticking with more straightforward estate planning techniques, all of which continue to be viable and effective. However, for those who want to make lifetime transfers but are concerned about outliving their wealth, a spousal access trust may be a technique to discuss further with an estate planning attorney, BBH wealth planner, or relationship manager.