Spousal Remainder Annuity Trust ("SRAT")
When a couple's financial assets have reached a level of at least twice the applicable exemption ($1,350,000 as of 2000) it is appropriate to investigate planning vehicles to supplement the classic Revocable Living Trust utilizing the Marital Trust and Family Trust concept. One vehicle which we recommend is the Spousal Remainder Annuity Trust ("SRAT").
Example:
Husband creates an irrevocable trust for wife with $300,000 in assets. Husband applies $300,000 of his $675,000 applicable exemption amount to the gift in order that no gift tax is payable. Each year thereafter for 10 years husband transfers $10,000 to the SRAT and claims the $10,000 annual exclusion from gift tax for the transfer. If the trustee earns 7% on the investments, the SRAT will be worth approximately $738,000 in ten years. The trust agreement provides that the trustee (who may be the wife) (i) pays income to wife, (ii) may retain and grow the trust principal, or (iii) may distribute principal to the wife for her health and maintenance. Upon the death of the wife, the trust property may pass to the children.
The SRAT therefore has the following advantages:
- The value of the assets used to fund the SRAT and all the subsequent appreciation should be excluded from both the husband's and wife's estate for federal estate tax purposes.
- The income and principal of the SRAT should be available to the wife should the need arise in the future.
- The SRAT may include a special power of appointment that would allow for a change in the distribution pattern to be accomplished during the husband's life.
- The SRAT is taxed for income tax purposes as if the income were earned by the husband. Therefore, there are no adverse income tax consequences to the establishment of the SRAT.
- It is possible for both the husband and the wife to establish SRATs as long as the reciprocal trust doctrine is avoided.
- The SRAT has the following disadvantages:
- It requires independent administration and operation.
- If the wife (in example above) dies before the husband, the assets are distributed in accordance with the terms of the trust (in our example above the children) and therefore, are no longer available to the husband.
There are two situations where this technique is particularly attractive.
FACTS: Husband and wife (both retired), each age 60, have $1,000,000 in non-retirement plan financial assets, a $250,000 residence and husband has a $1,000,000 IRA which includes a roll-over from his former employer's 401(k) plan. Properly, husband and wife have historically divided their non-IRA assets so that approximately one-half (1/2) of the value thereof is in each of their Revocable Living Trusts (i.e., each Revocable Living Trust has $675,000 in value), utilizing the Martial/Family Trust concept.
OPTION 1:
The husband and wife make no change in their current plan, and (1) their assets grow at a rate of 7% per year; (2) the husband dies in 10 years; and (3) the wife dies in 15 years.
Result: The total federal estate tax payable upon the second death is approximately $2,052,556.
OPTION 2:
(1) The assets still grow at a rate of 7% per year; (2) the husband still dies in 10 years; and (3) the wife still dies in 15 years, except the wife creates a $200,000 SRAT for the benefit of the husband; wife contributes $10,000 to the SRAT each year after its creation for the 10 years the husband lives. Husband withdraws $25,000 more from the IRA than he currently withdraws (at an income tax cost of $7,500) and places the $17,500 after tax withdrawal in the wife's trust to begin to replace the $200,000 utilized by the wife to fund the SRAT.
Result: The total federal estate tax payable upon the second death is approximately $1,769,731.
Conclusion
THEREFORE, ONLY A $200,000 SRAT PROVIDES AN EXTRA $280,000 FOR THE FAMILY THAT WOULD HAVE OTHERWISE BEEN PAID IN FEDERAL ESTATE TAX!
