Intentionally Defective Grantor Trusts (IDGTs) and Spousal Lifetime Access Trusts (SLATs) are two popular types of irrevocable trusts. How do you know which one is right for you? This article explains what these trusts are and when they make sense.

Key Highlights and Takeaways

• Two Powerful Estate Tax Strategies: IDGTs and SLATs both save estate tax, but they’re used in different circumstances.
• IDGTs are Tax-Efficient, Flexible Trust Structures: IDGTs are highly estate-tax efficient and make a lot of sense for people who are interested in transferring wealth to future generations and have not used their entire lifetime gift tax exemptions. A grantor can loan to, sell to, and borrow from an IDGT.
• SLATs are Tax-Efficient Trusts for the Grantor’s Spouse: SLATs are very estate-tax efficient and make a lot of sense for people who want to transfer wealth to future generations and have not used their entire lifetime gift tax exemptions. What distinguishes SLATs from other irrevocable grantor trusts is that they name the grantor’s spouse as a primary beneficiary.

What is an IDGT?

An IDGT is a type of irrevocable trust that is optimized for estate-tax efficiency. A person (the “grantor”) creates an IDGT for the benefit of one or more loved ones — such as children, grandchildren, a spouse, or siblings. The grantor funds the trust using a portion of his or her lifetime gift and estate tax exemption. Once an asset is in the trust, that asset is outside the grantor’s estate and will never be subject to gift tax, estate tax, or generation-skipping transfer tax as long as it remains in the trust. Any resulting appreciation will also be outside the grantor’s estate. Because an IDGT is a “grantor trust,” the grantor has the option to pay the trust’s taxes without that being considered a gift, which is a way to transfer additional wealth to the trust. This makes IDGTs even more estate-tax efficient than they would otherwise be. (You can learn more about IDGTs here.)

IDGT Example

Imagine that Teresa is a New York City resident with a $25 million net worth and a portfolio that generates 9% annual returns (divided equally between capital appreciation and cashflow). If Teresa sets up an IDGT for the benefit of her daughter and then contributes a $6 million asset to it, she will use up $6 million of her lifetime gift tax exemption, but the asset will be able to grow outside of her taxable estate. Teresa will also be able to pay the trust’s income taxes, allowing the trust to generate 9% annual post-tax returns and shifting more wealth out of Teresa’s taxable estate. After 25 years, the IDGT’s assets will be worth about $51.7 million! And if Teresa dies in Year 25, she will have saved her daughter about $20.4 million of tax that she would have otherwise owed.

Benefits of IDGTs

1. Estate Tax Savings: The primary advantage of an IDGT is its ability to use a grantor’s lifetime gift tax exemption to efficiently shift assets out of the grantor’s estate for estate-tax purposes. The grantor can pay the income tax on the trust’s income, effectively shifting even more wealth into the trust and out of the grantor’s estate. Finally, the grantor can lend to the trust free of any tax consequences — loans are another powerful tool that taxpayers use to shift wealth out of their estates.
2. Asset Protection: An IDGT, as a separate legal person, is generally not subject to liability for actions taken by a trust’s grantor or beneficiary. So the grantor’s or beneficiary’s creditors won’t be able to access the trust’s assets even if they win a lawsuit against the grantor or beneficiary. In addition to protecting assets from lawsuits, IDGTs can help shield inherited assets from a divorcing spouse.
3. Potential Income-Tax Savings: Although IDGTs don’t provide any immediate income-tax savings, they can indirectly save income tax down the line. That’s because an IDGT can make distributions to other taxpayers, who may be in lower tax brackets. The distribution itself will have no tax consequences, but when those taxpayers later sell the asset, they’ll pay less tax than the grantor would have paid, due to that lower tax bracket. IDGTs can also be transformed into “non-grantor trusts,” which can avoid state income tax.
4. Relative Liquidity: Compared to many other tax strategies, IDGTs have little impact on a grantor’s liquidity. Though the grantor will have transferred some portion of his or her assets to the trust, the grantor can borrow from the IDGT without any tax consequences. Moreover, if the grantor’s spouse is a beneficiary, he or she can receive distributions from the IDGT if necessary.
5. Ideal for Illiquid Assets: IDGTs work well whether funded with liquid or illiquid assets.
6. GST Efficiency: A person can allocate generation-skipping transfer (”GST”) tax exemption to a IDGT when the trust is first funded. As a result, the IDGT is a popular form of dynasty trust.

Drawbacks of IDGTs

1. No State Income Tax Savings: IDGTs don’t save state income tax unless they’re converted to non-grantor trusts.
2. Irrevocability: When a grantor makes a gift to an IDGT, the gift is irrevocable (though the grantor can swap assets in and out of the trust at any time, as long as the swapped assets are exchanged for other assets with equal value).
3. No Direct Control: Typically the grantor does not act as trustee of the IDGT, though he or she can remove and replace the trustee at any time, lend money to or borrow money from the trust, get reimbursed by the trust for the trust’s tax liabilities (if the grantor doesn’t want to pay), and swap assets with the trust.

What is a SLAT

A SLAT is a particular type of intentionally defective grantor trust (IDGT), and has much in common with other IDGTs. A person (the “grantor”) creates a SLAT and names the grantor’s spouse as either the sole initial beneficiary or one of the initial beneficiaries. Typically upon the sooner of the spouse’s death or divorce, the remaining trust principal is split into separate trusts for the grantor’s descendants. The grantor funds the trust using a portion of his or her lifetime gift and estate tax exemption. Once an asset is in the trust, that asset is outside the grantor’s estate and will never be subject to gift tax, estate tax, or generation-skipping transfer tax as long as it remains in the trust. Any resulting appreciation will also be outside the grantor’s estate. Yet, because the grantor’s spouse is a beneficiary, the grantor’s spouse can receive distributions. This can give the grantor “backdoor access” to the trust principal (though distributing SLAT principal to the grantor’s spouse is generally not very tax efficient). Because a SLAT is a “grantor trust,” the grantor has the option to pay the trust’s taxes, which is a way to transfer additional wealth to the trust. This makes SLATs even more estate-tax efficient than they would otherwise be. (You can learn more about SLATs here.)

SLAT Example

Imagine that Ellen is a New York City resident with a $25 million net worth and a portfolio that generates 9% annual returns (divided equally between capital appreciation and cashflow). If Ellen sets up a SLAT for the benefit of her spouse and then contributes a $6 million asset to it, she will use up $6 million of her lifetime gift tax exemption, but the asset will be able to grow outside of her taxable estate. Ellen will also be able to pay the trust’s income taxes, allowing the trust to generate 9% annual post-tax returns and shifting more wealth out of Ellen’s taxable estate. After 25 years, the SLAT’s assets will be worth about $51.7 million! And if Ellen dies in Year 25, she will have saved her heirs about $20.4 million of tax relative to the counterfactual where she hadn’t funded the SLAT.

Benefits of SLATs

1. Estate Tax Savings: The primary advantage of a SLAT is its ability to use a grantor’s lifetime gift tax exemption to efficiently shift assets out of the grantor’s estate for estate-tax purposes. The grantor can pay the income tax on the trust’s income, effectively shifting even more wealth into the trust and out of the grantor’s estate. Finally, the grantor can lend to the trust free of any tax consequences — loans are another powerful tool that taxpayers use to shift wealth out of their estates.
2. Asset Protection: A SLAT, as a separate legal person, is generally not subject to liability for actions taken by a trust’s grantor or beneficiary. So the grantor’s or beneficiary’s creditors won’t be able to access the trust’s assets even if they win a lawsuit against the grantor or beneficiary. In addition to protecting assets from lawsuits, SLATs can help shield inherited assets from a divorcing spouse.
3. Potential Income-Tax Savings: Although SLATs don’t provide any immediate income-tax savings, they can indirectly save income tax down the line. For example, if the grantor names both the grantor’s spouse and the grantor’s child as beneficiaries, the trustee can distribute an appreciated asset to the grantor’s child, who may be in a lower tax bracket. The distribution itself will have no tax consequences, but when the grantor’s child later sells the asset, he or she will pay less tax than the grantor would have paid, due to that lower tax bracket.
4. Liquidity and Indirect Access: Compared to many other tax strategies, SLATs have little impact on a grantor’s liquidity. Though the grantor will have transferred some portion of his or her assets to the trust, the grantor can borrow from the SLAT without any tax consequences. Moreover, the grantor’s spouse can receive distributions from the SLAT if necessary.
5. Ideal for Illiquid Assets: SLATs work well whether funded with liquid or illiquid assets.
6. GST Efficiency: A person can allocate generation-skipping transfer (”GST”) tax exemption to a SLAT when the trust is first funded. As a result, the SLAT is a popular form of dynasty trust.

Drawbacks of SLATs

1. No State Income Tax Savings: Unlike non-grantor trusts, SLATs don’t save state income tax.
2. Grantor Trust Status Locked in: With grantor trusts where the spouse is not a beneficiary, the grantor can always turn off grantor trust status and, by doing so, transform the trust into a non-grantor trust. However, as long as the grantor’s spouse is a beneficiary of a SLAT, this isn’t possible. While grantor trust status is generally desirable, there are situations where grantor trust status is inefficient. The ability to turn grantor trust status off is a valuable perk, one that SLATs can’t offer.
3. Separate Property: SLATs must be funded with the grantor’s sole and separate property — if a SLAT is funded with the spouse’s property, the SLAT will fail to avoid estate tax (at least in part). Since many couples own most of their property jointly or as community property, this can be a problem. Where it is a problem, both spouses must agree in advance of the SLAT being funded that the property that’s funding the SLAT is the grantor’s separate property. Understandably, sometimes married couples aren’t comfortable signing documents that transfer property from one spouse to another.
4. Irrevocability: When a grantor makes a gift to a SLAT, the gift is irrevocable (though the grantor can swap assets in and out of the trust at any time, as long as the swapped assets are exchanged for other assets with equal value).
5. No Direct Control: Typically the grantor does not act as trustee of the SLAT, though he or she can remove and replace the trustee at any time, lend money to or borrow money from the trust, get reimbursed by the trust for the trust’s tax liabilities (if the grantor doesn’t want to pay), and swap assets with the trust.

Should You Set Up an IDGT or a SLAT?

IDGTs and SLATs both save estate tax. They’re also very similar vehicles — in fact, SLATs are a type of IDGT. Non-SLAT IDGTs are a bit more flexible, because the grantor can always turn off grantor trust status, and they’re also a bit simpler because they can be funded with community property or other joint marital assets. On the other hand, SLATs can give the grantor some peace of mind, knowing that he or she can always indirectly access the trust assets through his or her spouse.

Ultimately, whether to set up a conventional IDGT or a SLAT is a personal choice. SLATs tend to be fairly popular with people who have less than $40 million of wealth and want to move assets out of their estate, but are also a bit worried about giving away too much of their wealth during their lifetimes. Pure IDGTs are the go-to choice for people who are focused on transferring wealth to their descendants and aren’t too concerned about running out of money.

It is important to note that there are lots of other gift and estate tax strategies that may make more sense than an IDGT or a SLAT, depending on circumstances. Those strategies are also worth exploring. Moreover, IDGTs and SLATs are not mutually exclusive; some people set up both.

Conclusion

IDGTs and SLATs are both powerful estate-tax strategies. Hopefully this article has given you a better idea of what each structure entails, and whether one or the other might be a better fit.

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