Strategic Case Design

Irrevocable Spousal Lifetime Access Trust

How the I-SLAT can provide income for the spouse of the grantor

by Russell E. Towers JD, CLU, ChFC

Mr. Towers is Vice President – Business & Estate Planning with Brokers' Service Marketing Group, Providence. Connect with him by e-mail: [email protected]

One drawback to a typical Irrevocable Life Insurance Trust (ILIT) is that your client and spouse lose direct access to the policy cash values during lifetime. This loss of access to potential tax free policy withdrawals (FIFO) may cause your client to hesitate when considering an ILIT.

One way to overcome this objection is with an Irrevocable “Spousal Lifetime Access Trust” (I-SLAT). The I-SLAT incorporates special trust language that allows the spouse of the grantor limited lifetime access to cash values while still keeping the ultimate death benefit estate tax free. And the I-SLAT can be implemented using either a single life UL cash accumulation type of policy or a survivorship life SUL type of policy.

Current assumption UL/SUL or indexed UL/SUL can provide the perfect vehicles to make this concept attractive to your client. Take a look at the simple examples below that can help your client decide in favor of taking action now to provide estate tax free access to policy cash value for a spouse and family:

Single Life – Irrevocable 'SLAT'

  • I-SLAT is the owner and beneficiary of a competitive $2,000,000 current assumption UL or indexed UL policy on the life of a 50 year old grantor who makes overfunded premium gifts to the trust of $50,000 each year for 15 years. No more premiums are planned to be paid after age 65.
  • The I-SLAT language gives the spouse of the grantor a limited power of appointment to withdraw the greater of 5% or $5,000 from trust principal (cash value) each year non-cumulatively (a so-called “5 and 5 power”).
  • Starting in year 11, the spouse exercises the power to make withdrawals up to a maximum of 5% of the cash value each year for 15 years tax free (about $35,000 per year). This limited power must be executed each year by the spouse and is non-cumulative. This means that the spouse must use it or lose it. In other words, the spouse cannot go back in time to use any unexercised powers from prior years.
  • The trustee makes a tax free withdrawal of basis (FIFO) of about $35,000 from the policy each year and forwards the cash to the spouse. This distribution from the trust retains its tax free character when distributed to the spouse.
  • The spouse of the insured grantor may be the trustee of the I-SLAT without causing the death benefit to be included in the spouse’s own gross estate for estate tax purposes
  • The 5% withdrawal power continues for the spouse even after the death of the grantor. Of course, the trust principal will be greatly enhanced by the income tax free death benefit.
  • The policy must be closely monitored during the lifetime of the grantor to make sure it never lapses because of excess withdrawals, policy underperformance, unpaid policy loan interest, or increasing cost of insurance charges.

Survivorship Life – Irrevocable 'SLAT'

  • I-SLAT is the owner and beneficiary of a competitive $4,000,000 current assumption SUL or indexed SUL policy on the joint lives of a 50 year old grantor and 50 year old spouse. The grantor makes overfunded premium gifts to the trust of $60,000 each year for 15 years. No more premiums are planned to be paid after age 65.
  • The I-SLAT language gives the spouse of the grantor a limited “5 and 5 power” to make withdrawals from trust principal (cash value) each year.
  • Starting in year 16, the spouse exercises the power to make withdrawals up to a maximum of 5% of the cash value each year for 15 years tax free (about $45,000 per year). This limited non-cumulative power must be executed each year by the spouse.
  • The trustee makes a tax free withdrawal of basis (FIFO) of about $45,000 from the policy each year and forwards the cash to the spouse. This distribution from the trust retains its tax free character when distributed to the spouse.
  • Neither spouse may be a trustee of the I-SLAT due to the fiduciary “incident of ownership” rules (i.e. an insured cannot be the trustee of an irrevocable trust that owns insurance on their life). A third party trustee, co-trustees, or a corporate trustee could be named as the trustee fiduciary of the trust.
  • The policy must be closely monitored during the lifetime of both the grantor and spouse to make sure it never lapses because of excess withdrawals, policy underperformance, unpaid policy loan interest, or increasing cost of insurance charges.
The I-SLAT incorporates special trust language that allows the spouse of the grantor limited lifetime access to cash values while still keeping the ultimate death benefit estate tax free

Important Note: For the survivorship I-SLAT concept described above, if your client wants potential access to cash value amounts greater than 5% of trust principal annually, then the trust document can give the third party trustee discretion to distribute the larger amounts. The language of the survivorship life I-SLAT can be tailored by your client’s attorney to achieve this objective. Keep in mind that your client must rely on the trustee alone to make this decision to distribute amounts greater than 5% of trust principal.

The Bottom Life…

By adding the special limited “5 and 5 power” to the trust language, partial access to cash value can be made available for family lifetime needs without causing the death proceeds to be included in the gross estate of either spouse.