Financial Planning Insights

The Goldilocks Planning Solution to the Reduction in the Transfer Tax Exemption

By Joe Maier | Johnson Financial Group

5 minute read time

The Spousal Lifetime Access Trust

This is the first part of a three-part series on the use of a spousal lifetime access trust (or SLAT) to eliminate the risk of changes in the estate and gift tax system. This first article focuses on the separation of legacy assets from lifetime assets and why that is important. The second article will explore the SLAT as a planning solution to address the difficulties of making that separation. Finally, the third article deals with some design challenges that need to be managed in building a perfect SLAT (or SLATs).

Background

Legacy planning focuses on building a strategy to maximize the impact your wealth has on the people and causes you care about. In a legacy plan, the goal is to position the ownership of your assets so that they can be used to benefit the people and causes you care about, and prevent them from ending up with people you do not want to have them; including creditors, predators, former spouses and the government (in the payment of taxes).

A current challenge many legacy plans are facing is a potential change in the transfer tax exemption. As I write this article, a person can transfer up to $11.7 million without the imposition of gift or estate tax. Other than 2010, when there was no estate tax, this is the largest amount of wealth that the law has allowed to be given free of tax. But that valuable giving tool is currently at risk both from current bills in Congress that would shrink that amount to $3.5 million and from current law that will cut that amount in half on January 1, 2026.

With these potential changes, many people not currently subject to the transfer tax would be if the law is changed, and they are looking to their advisers for a solution to the problem. When we hear this concern, we often tell our clients any solution starts with the separation of those clients’ assets between those they will spend during their lifetimes (“lifetime assets”) and those they will not (“legacy assets”).

Lifetime vs. Legacy Assets- why the distinction is important

The first critical step of the legacy planning process is separating legacy assets from lifetime assets. Lifetime assets are those that you are going to liquidate and spend down during your lifetime. Legacy assets are all your assets that are not lifetime assets; in other words, those that you will own when you die. Stated another way, lifetime assets are used for you (or for you to spend on people or causes you care about); legacy assets are used for others. For most people, the process of calculating which of their assets are legacy vs lifetime assets is a two part process: (1) determine, based on assumptions, how much of your assets, income and appreciation you will spend for you personally, for your wishes, hopes, dreams and desires (these are your lifetime assets), and (2) based on those same assumptions, how much of your assets, income and appreciation you will not spend (these are your legacy assets). Once this calculation is complete, the next step in theory, is simple. Give away your legacy assets immediately. If your calculation is correct, you will not use your legacy assets; therefore, either they will end up in the hands of people you want to have them, such as families, friends or charities, or they will end up in the hands of people you do not want to get them, such as creditors, predators, former spouses or the government. The quicker you give legacy assets away, the greater control you have in getting them to the people you want to have them and keeping them away from others.

The Challenge: Assumptions

This “easy” solution of giving away legacy assets as fast as possible is almost never chosen. The reason lies in the inherent weakness of assumptions. If you think about the calculation of lifetime and legacy assets, the presumption is that lifetime assets are PRECISELY what you will spend during your lifetime. The last lifetime dollar should be spent on your coffin. In other words, the calculation leaves no room for error. And if the assumptions are too aggressive, that means the lifetime assets will be insufficient to pay for your wishes, hopes, dreams and desires. Or, stated in a less eloquent, but more frightening way, you will run out of money.

Having said that, presuming reasonable assumptions are made, there is an equal chance that the assumptions will be too conservative, and you will end up with more legacy assets than you gave away. Understanding those two possibilities helps to explain why almost no client gives away all the legacy assets. If the two possibilities are being aggressive and risking being penniless or being conservative and having the possibility of having too many assets exposed to creditors and taxes, the more palatable approach is the conservative one.

But is there a possibility of being more aggressive in classifying assets as legacy assets, but at the same time having the ability to convert the assets back to lifetime assets if the assumptions prove wrong? Using a SLAT to do just that is the subject of part II of this article.

ABOUT THE AUTHOR

Joe Maier

Joe Maier

SVP Director Wealth Strategy JD, CPA | Johnson Financial Group

Joe has extensive experience helping high‐net worth individuals, family offices, business owners and corporate executives meet their wealth and legacy goals. His areas of specific interest and skill include business succession planning, financial and estate planning, and wealth transfer strategies.