The final edition of this three-part series explores how a private annuity sale to an intentionally defective grantor trust (IDGT) may provide married clients with an alternative source of income while reducing reliance on spousal lifetime access trusts (SLATs). This three-part blog series offers a high-level, practice-oriented comparison for financially sophisticated readers. It is not legal, tax, or valuation advice. Outcomes are fact- and jurisdiction-specific and require coordinated professional wealth planning guidance.
Why Spouse No. 1 Might Prefer the IDGT Private Annuity
A lifetime annuity payable to spouse No. 1 from the IDGT can: 1. Deliver an income stream directly to spouse No. 1 without dependence on distributions from a spouse’s SLAT, thereby mitigating reciprocal trust concerns (discussed below) and access risk. 2. Reduce reliance on gift/estate exemption compared to a large up-front gift, because the sale is an exchange for value, although you may need to “fund” the trust with some “seed money” discussed below. 3. Provide diversification of risk: spouse No. 1 holds an unsecured annuity claim; spouse No. 2 can maintain separate planning (including SLATs) without entangling reciprocal structures.
The reciprocal trust concerns mentioned above pertain to the risk that if spouse No. 1 creates a SLAT for spouse No. 2, followed by spouse No. 2 creating a similar SLAT for spouse No. 1, this could invite an argument by the IRS that, in essence, spouse No.1 really created a trust for spouse No. 1 and spouse No. 2 really created a trust for spouse No. 2 since the two trusts were nearly identical and therefore viewed more as a “tit for tat” arrangement that in effect placed both spouses in the same economic position that they would have held had they each simply created a trust naming themself as a beneficiary (a “self-settled trust”).
In other words, each spouse still had access to a trust in which they were named a beneficiary, and therefore likely not left in a diminished financial situation as a practical matter. There has been case law that concludes that if the two trusts were significantly different from one another, then you can avoid the reciprocal trust doctrine.
These cases, however, were more focused on tax issues. It is still a gray area whether, for creditor/debtor asset protection purposes, a reciprocal trust rationale could still apply that persuades a court to conclude that trusts are really self-settled trusts, meaning that each beneficiary spouse has participated in transactions where they still have access to a trust that was created for their benefit.
In other words, if spouse No.1 creates a SLAT for spouse No. 2 and then spouse No. 2 creates a SLAT for spouse #1 knowing that this way, each spouse would still be a beneficiary of a trust with respect to selected assets, could these trusts in effect be self-settled since neither spouse truly relinquished their rights to all their collective assets as they would not have done so without knowing that they would be a beneficiary of another trust in which they would be named a beneficiary.
The temptation of reciprocal SLATS is that each spouse still has access to, perhaps, half of their collective assets if all else fails, and therefore still has access to a cash flow source for their needs. The private annuity sale arrangement accomplishes that without the need for the second SLAT.
Tradeoffs and Cautions With the Private Annuity
1. Annuity solvency and economic substance must be demonstrated; inadequate funding, weak guarantees, or circular cash flows risk inclusion or recharacterization.
2. If spouse No. 2 participates as guarantor or funder, avoid steps that could make spouse No. 2 a deemed co-grantor or create indirect gifts; sequencing and documentation matter. For example, the guarantor should be paid an arms’ length guarantor fee.
3. Longevity risk sits with the trust and beneficiaries; extended lifespans can erode residual value.
4. If grantor trust status ends, income tax dynamics can change materially; plan for contingencies.
Implementation Focus: Private Annuity to IDGT
Seed money vs. guarantees
1. Seed capital practice. Many practitioners target an initial funding cushion for the IDGT, often referenced at approximately 10 percent of the asset value to be purchased, to evidence the ability to satisfy the annuity, support economic substance, and buffer volatility. The actual level should be determined by cash flows, volatility, and pricing.
2. Third-party or beneficiary guarantees. Instead of—or in addition to—seed funding, a creditworthy guarantor may support the annuity. Appropriate guarantors might include adult beneficiaries, independent third parties, or well-capitalized entities not owned by the grantor in a manner that risks inclusion. Key considerations include commercial reasonableness, arm’s-length terms, fair-value guarantee fees, avoiding additional gifts, and preventing circularity.
Sequencing to avoid deemed co-grantor issues for married clients
1. Avoid indirect gifts by spouse No. 2 to spouse No. 1’s IDGT. Do not route spouse No. 2’s wealth into spouse #1’s trust shortly before the sale or through circular loans that finance the very purchase.
2. Document independent funding sources for the IDGT, separate guarantees with market-rate compensation, and sufficient lead time between any spouse-to-spouse transfers and the IDGT’s purchase. Keep formal minutes, execute contemporaneous valuations, and maintain clean payment flows that do not return to the grantor or spouse through related entities. One step cannot be dependent on the other. Intervening independent reasons should arise that lead to spouse No. 2 transferring assets to spouse No. 1. Spouse No. 2 should not transfer assets to spouse No. 1 “so that spouse No. 1 can place those same assets or assets of equal value to the SLAT.” For example, if spouse No. 2 engages in a high-risk profession, he/she may want to transfer assets to a spouse for asset protection reasons (although the effectiveness or advisability of such an asset protection strategy warrants a separate conversation beyond the scope of this post).
Final Thought
Both GRATs and a private annuity sale to IDGT are powerful, but they reward precision: credible valuations, disciplined modeling, and careful documentation. Coordinate early with estate planning counsel, tax advisors, and valuation professionals to tailor the approach, validate assumptions, and align the structure with family, liquidity, and governance goals.
This publication is provided by Greenspoon Marder LLP is issued for informational purposes only and is not intended to be construed or used as general legal advice nor a solicitation of any type. Please contact the author(s) or your Greenspoon Marder LLP contact if you have any questions regarding the currency of this information. The hiring of a lawyer is an important decision. Before you decide, ask for written information about the lawyer’s legal qualifications and experience.