Back to Missives
George F. Bearup, J.D. Senior Legal Trust Advisor

15-Sep-20

Remainder Purchase Marital Trust

Take-Away: A Remainder Purchase Marital Trust (RPM Trust) is sometimes described as an alternative to a spousal lifetime access trust (SLAT) or a grantor retained annuity trust (GRAT.) Like a SLAT or a GRAT, an RPM Trust is a sophisticated estate planning technique that is intended to remove assets from the spouses’ taxable estates, with little or no transfer tax incurred (a SLAT alternative.) An RPM Trust might be used if the spouses do not have any transfer tax exemption available but still want to shift wealth (a GRAT alternative). An RPM Trust can be much more flexible than a GRAT with all of its technical rules. As individuals explore making lifetime gifts before the end of 2020, an RPM Trust might be  one more planning technique to consider, although it is admittedly very complex.

Background: An RPM Trust involves the transfer of assets to an irrevocable trust in which the donor’s spouse has an income interest or an annuity interest for a specified term or the beneficiary-spouse’s life. The remainder interest of the RMP Trust is purchased by a separate trust ( for ease, referred to as the Remainder Trust) which could be a generation skipping trust. The transfer of assets to the RMP Trust is gift tax-free because the spouse’s income or annuity interest in the trust qualifies for the federal gift tax marital deduction. [IRC 2523(a).] The Remainder Trust pays the actuarial value of the remainder interest in the RPM Trust’s donor. The RPM Trust assets are not included in either the donor’s taxable estate, because the donor has no retained interest in the RPM Trust, nor are they included in the beneficiary-spouse’s estate because the beneficiary-spouse neither possesses a general power of appointment over the RPM Trust’s assets nor is there a QTIP election with regard to the Trust.

Terminable Interest Rule: No gift tax marital deduction is allowed if, upon the occurrence of an event or on the lapse of time, the spouse’s interest in the transferred property will end and, as a result, the property passes to another person “for less than adequate and full consideration in money or money’s worth.” This is referred to as the terminable interest rule with regard to the marital deduction. [IRC 2523(b).] Two ‘triggers’ exist to the terminable interest rule by which the terminable interest held by the spouse will nonetheless qualify for the gift tax marital deduction: (i) a general power of appointment [IRC 2523(e)] and (ii) a QTIP election is made. [IRC 2523(f).] If either of these is used, the trust property, while subject to the federal gift tax marital deduction, will also cause the trust assets to be included in the beneficiary-spouse’s taxable estate. It is this technical definition that is exploited with a RPM Trust, where the marital deduction can be claimed on the transfer of assets to that trust, but without estate inclusion on the beneficiary-spouse’s death.

RPM Trust Example: George creates an irrevocable trust ( the RPM Trust) and transfers assets to that trust in which George’s wife, Barbara, has an annuity interest for her lifetime. After Barbara’s life, the trust assets are to pass back to George. A separate Remainder Trust is also created, preferably by another family member (the Remainder Trust.) At the time the RPM Trust is created and funded, the Remainder Trust pays George for its purchase of the remainder interest in the RPM Trust. Barbara’s interest qualifies for the federal gift tax marital deduction. The interest acquired by the Remainder Trust established for their son Jeb and his descendants is not a gift because it is purchased. The RPM Trust for Barbara does not have a general power of appointment and no QTIP election will be made by George, yet the RPM Trust assets will qualify for the federal gift tax marital deduction, but not be included in Barbara’s estate at the time of her death. The interest in the RPM Trust transferred to Barbara qualifies for the gift tax marital deduction even though the Remainder Trust established for Jeb will receive the remainder interest after the termination of Barbara’s interest on her death. Because the Remainder Trust created for Jeb pays George adequate and full consideration for its remainder interest, IRC 2523(b) does not apply yet the gift of the annuity interest to Barbara still qualifies for the federal gift tax marital deduction.

RPM Trust Specifics and Mechanics: There are several technical steps and considerations when an RPM Trust is set up.

  • Income or Annuity Interest: The beneficiary-spouse should only have an income or annuity interest in the RPM Trust. If the beneficiary-spouse possessed the right to receive distributions under an ascertainable or discretionary standard, the beneficiary-spouse’s interest would be extremely difficult to value, thus making it difficult to value the remainder interest in the RPM Trust which controls the purchase price paid to the donor-settlor. Since current interest rates are so low, it is more advantageous to provide an annuity for the beneficiary-spouse under the RPM Trust.
  • Remainder Trust:  The gift of the income or annuity interest to the donor’s spouse and the sale of the remainder interest to the Remainder Trust must occur simultaneously. If the sale is deemed to occur after the donor’s gift to the RPM Trust, the gift will not qualify for the marital deduction. If the sale occurs before the gift of the annuity interest to the donor’s spouse, the donor will have retained an interest in the transferred property and IRC 2702 would apply to cause the value of the remainder interest to be equal to the full value of the property for gift tax purposes. It is also advisable that the Remainder Trust be created by someone other than the donor-spouse to avoid the terminable interest rule with regard to the gift tax marital deduction. In addition, the beneficiary-spouse should not be a beneficiary of the Remainder Trust to also avoid implications of IRC 2702.
  • Purchase of Remainder: The beneficiary-spouse’s interest is not subject to the terminable interest rule because of the statutory exception to the terminable interest rule that there is a purchase of the remainder interest for adequate and full consideration. Consequently, in order to avoid any terminable interest concerns, it is critically important that full consideration be paid for the remainder interest in the RPM Trust. It is best to use a defined value allocation formula in the settlor’s sale of the remainder interest in the RPM Trust to the Remainder Trust to avoid any gift tax exposure.
  • Grantor Trust: During the settlor’s lifetime the RPM Trust should be structured as a grantor While the trust will be classified as a grantor trust since the grantor’s spouse is the trust beneficiary [IRC 677] it is probably wise to include other grantor trust powers, e.g. the right to substitute assets of equivalent value; the right to borrow trust assets, to ensure the entire trust is classified as a grantor trust (not just the amount of assets necessary to pay the annuity to the beneficiary-spouse.). No capital gain will be realized on funding the RMP Trust with appreciated assets while both spouses are living. If any portion of the annuity paid to the beneficiary-spouse uses assets that have unrealized gains, the RPM Trust would normally will be deemed to have sold such assets which will cause the taxable gain to be recognized. However, since the RPM Trust is a grantor trust and the annuity is payable to the grantor’s spouse, because the exchange will be considered between the grantor and his/her spouse, the use of appreciated assets to pay the annuity to the beneficiary-spouse will not result in gain recognition. [IRC 1041.]

Advantages of an RPM Trust: When comparing and contrasting an RPM Trust with a SLAT or a GRAT consider the following attributes of the RPM Trust:

  • The RPM Trust has the income tax advantages of a grantor
  • Unlike a GRAT, the near-term death of the donor or the donor’s spouse (i.e. estate inclusion) does not affect the transfer tax effectiveness of the RPM Trust strategy.
  • The RPM Trust is more efficient than a GRAT and is not dependent upon superior investment returns, i.e. RPM Trust does not have to beat any investment hurdle (the IRC 7520 rate) to achieve the wealth transfer goal.
  • The appreciation of the RMP Trust’s assets will be out of the donor’s taxable estate. That appreciation also escapes inclusion in the beneficiary-spouse’s taxable estate, much like a SLAT.
  • The donor and the donor’s spouse will have available for their consumption for their lifetimes the consideration paid by the Remainder Trust to the donor and the stream of the annuity payments. Restated, the donor and donor’s spouse could regain access to some of the assets that were used to fund the Remainder Trust, along with the distributions paid under the beneficial provisions of the RMP Trust to the beneficiary-spouse, so it functions something like a SLAT.
  • There is more flexibility in the design of the structure of a RPM Trust, compared to a GRAT or a QPRT (which are statutorily authorized under IRC 2702.
  • It is easier to leverage the donor’s GST exemption with the RPM Trust than with a GRAT, because the donor’s GST exemption cannot be assigned until after the estate tax inclusion period (ETIP)  with a GRAT. In other words, the remainder interest in the RPM Trust can immediately pass to and be held by a GST exempt Remainder Trust.
  • The joint purchase rule of IRC 2702 does not apply to a RPM Trust because the donor’s spouse has not paid any consideration for her term or annuity interest in the RPM Trust.
  • Unlike a GRAT, the annuity amount paid by the RMP Trust to the beneficiary-spouse could be paid with loan amounts or note, which cannot be done with a GRAT.
  • The annuity paid to the beneficiary-spouse could adjust/appreciate significantly each year, in contrast to a GRAT where the annuity amount paid cannot increase above 20% from year-to-year.
  • The RPM Trust could serve as a qualified personal residence trust (QPRT) substitute. Unlike a regular QPRT where the settlor is limited to two residences, a RPM Trust is not limited to the number of residences it may hold. Moreover, if one residence was sold the RPM Trust would not have to automatically convert to a GRAT if it was intended to function like a surrogate QPRT.

Conclusion: As individuals explore large gifts prior to the end of 2020, where SLATs and GRATs seem to be gaining a lot of attention, the benefits of a RPM Trust, despite its complexity, should also be considered.  With the low IRC 7520 interest rate, an annuity interest will tend to be ‘overvalued’ leading to a much lower purchase price to be paid by the Remainder Trust for its interest in the RPM Trust. If the donor has no transfer tax exemption available to use to fund a SLAT, then an RPM Trust may be a viable substitute to the use of a SLAT. If the donor wishes to shift appreciation in assets out of the donor’s taxable estate, but does not want to contend with the strictures of a GRAT, then a RPM Trust could provide the same benefits with a bit more flexibility. The trade-off, of course, is the inherent complexity of the RPM Trust strategy.

Note: For more reading on the RPM Trust strategy, several articles have been written by its ‘creators’ David Handler and Deborah Dunn.  “RPM Trusts: Turning the Tables on Chapter 14,” Trusts & Estates, July 2000 at 31; “GRATs and RPM Annuity Trusts: A Comparison,” Tax Management Estate, Gift and Trust Journal, Vol 29, no. 4, July 8, 2004 ; “RPM Trusts: A ‘Great’ Alternative,” Special Supplement to Lawyers Weekly USA, Jan. 24, 2004 at 1.