The Advantages of Gifting, Without the Gift
From an estate planning perspective, lifetime gifts offer several significant advantages over bequests at death. With the new $5 million exemption from estate tax scheduled to expire at the end of next year, many individuals are considering making large gifts at this time. However, the problem with most lifetime gifts is that you lose access to the gifted asset. Considering the current economic environment, many are reluctant to part with significant assets for fear they may someday be needed. Fortunately, there is an increasingly popular technique that will permit the advantages of lifetime gifting without forgoing access to the gifted assets.
The technique is known as a Spousal Access Trust (SAT). The SAT is simple to establish and can provide enormous estate tax savings. Assume that Husband establishes a trust for the benefit of Wife. Wife can be the sole beneficiary and sole trustee of the trust. Assume Husband transfers $5 million of securities to the trust and files a gift tax return to declare the gift. No gift tax would be owed because of the $5 million exemption. That $5 million is now excluded from the Husband’s estate and all future appreciation and income accumulations are also excluded from his estate. The assets are also not included in Wife’s estate even though she has complete access to them. After Husband and Wife are both deceased, remaining assets will pass to their children or other intended beneficiaries free of estate tax. Wife can establish a similar trust for Husband to be funded with her $5 million exemption amount.
If Husband or Wife lives for several years after establishing the trusts, the total tax savings can be dramatic. For example, if the trust portfolio yields a total of eight percent annually and if either parent lives eighteen years, the total tax savings could be nearly equal to the amount transferred to the trust. If a single trust were funded with $2 million, then the savings would approach $2 million. The savings from funding two trusts with a total of $10 million could be $10 million.
Some additional refinements to the SAT can enhance its potential benefits. For example, the trust can be designed as a “grantor” trust. If that option is selected, then the income earned by the trust will be taxable to the parent who established the trust, instead of being taxed to the trust itself. Since the trust will not pay tax on its earnings, it will, in effect, appreciate at pre-tax rates. Allowing the parent to pay the tax on trust earnings will also help in controlling the family’s total estate tax exposure by annually depleting the parent’s estate by the amount of the tax paid. That shifting of income tax liability from the trust to the parent will have a dramatic effect on the family’s total tax liability.
Another enhancement which could significantly improve the estate tax savings would be to fund the trust with discountable assets such as stock in a closely held company or shares in a family partnership holding a securities portfolio. The taxable value of those assets is often 30% or 40% less than the true value of the underlying assets. That discount will allow significantly larger amounts to be transferred to the SAT. There has been considerable discussion about eliminating those intra-family discounts, but until that happens they will continue to be used.
Individuals who are not married can also transfer assets out of their estates and still retain access, but a different type of trust must be used. The end result is nearly the same. Namely, significant assets will be held in a trust that is appreciating and accumulating income outside of your estate while you still retain access if that is ever needed.
An additional, non-tax benefit of a SAT is that the assets transferred to the trust are generally not reachable by either parent’s creditors. If Husband transferred $2 million to a trust for Wife, and she transferred $2 million to a trust for him, then that $4 million would be perpetually secure from the creditors of both parents. If either were ever sued from an auto accident, a business deal gone bad or any other reason, the assets in trust would be secure.
The advantages of lifetime gifts can be substantial and dramatic. Unfortunately, most estate tax planning techniques involve the transfer of assets out of the parent’s taxable estate and out of his or her reach. The Spousal Access Trust is a notable exception. It allows all the benefits of a gift without losing access or control.