Financial Planning Insights

Part II of III: The Goldilocks Planning Solution to the Reduction in the Transfer Tax Exemption

By Joe Maier | Johnson Financial Group

6 minute read time

The Spousal Lifetime Access Trust

This is the second article 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. The first article focused on the separation of legacy assets from lifetime assets and why that is important. This second article explores the SLAT as a planning solution to address the difficulties of making that separation. Finally, the third article addresses some design challenges that need to be managed in building a perfect SLAT (or SLATs).

Background

In the first article in this series, we focused on the distinction between lifetime and legacy 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. 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.

As stated in the first article, the major challenge is the assumptions that go into this calculation. If those assumptions are relatively accurate, the strategy of giving away legacy assets and keeping only lifetime assets achieves the goal of maximizing the impact of your wealth on the people and causes you care about. But, if the assumptions are incorrect, there is a risk that you will run out of money. That risk causes most clients to make overly conservative assumptions, exposing too much of their wealth to creditors and taxes.

This article will provide a solution to this conundrum; a solution that allows you to convert legacy assets back to lifetime assets if your assumptions prove incorrect. The solution is known as the spousal lifetime access trust or SLAT.

Basics of Creditor Protection

If someone owns property, and then incurs some type of creditor exposure, those assets are subject to seizure by those creditors. To avoid that risk, the property owner can give those assets away, but of course, that means the owner does not have the use or enjoyment of that property. Thinking about that, a potential solution is to give the property away to a trust wherein there is a possibility that the property can be used for the creator’s benefit. The challenge is that in most states, the law defeats that planning idea; if the trust creator is also a trust beneficiary, the trust’s assets continue to be subject to seizure by the creator’s creditors.

Basics of Estate Inclusion

Likewise, giving property away avoids that property being included in your gross estate and subject to estate tax. Given that there is also a gift tax that taxes lifetime transfers, gifts tend to have two advantages over bequests:

  • Any future appreciation in the property given away is not subject to the tax.
  • A gift can be made at a time where the donor knows exactly what the exemption is. That is not true of a bequest; the exemption has a possibility (perhaps even a strong one) of changing before the would be donor passes away. This is becoming of greater planning importance given the political volatility of the estate tax exemption.

The main disadvantage of an outright gift is the possibility of making the incorrect assumption that the gifted property is legacy property and the donor needing to use the property for lifetime expenses. It seems logical a concerned donor would attempt to deal with this concern by giving property to a trust wherein the donor has the possibility of enjoyment of the property if needed. But like the laws surrounding creditors, this planning technique will generally prove fruitless. The property of that trust will likely come back into the donor’s estate at death.

Spousal Trusts as a Solution

The problem with using a trust as a purported solution to issues of creditor protection, estate inclusion and potential future enjoyment is that the law prevents the trust’s creator from having a beneficial interest in the trust. What the law does not prevent is creation of a trust for another; that trust will protect the property from the creator’s creditors and inclusion in the creator’s estate. The obvious challenge is when the trust is created for another, it is this person who has the possibility of enjoyment, not the creator. Logically, the only solution to this problem would be if this other person’s economic interests were aligned with the creator’s. Is there such a person?

In a marriage that can be characterized as an economic partnership, that person would be the creator’s spouse. In this type of marriage, there is no mine and yours, only ours. So, if one spouse takes property and transfers it to a trust for the other; and the other spouse does the same, the spousal partnership continues to have the possibility of enjoyment over all of the trust property. This enjoyment allows the property of these trusts to be accessed if the need arises to convert the trusts’ legacy property back to lifetime property. Each trust can be designed so that the non-creator spouse can be the beneficiary of the trust, and with careful design, the trustee as well. In fact, to a large extent, the trust can be designed to mimic the outright ownership of the non creating spouse. So if assumptions were incorrect, the spouses can collectively access the trusts’ property, converting such property from legacy property to lifetime.

In conclusion, SLATs create an effective and elegant solution to “safely” converting lifetime property to legacy property, thereby protecting the property from creditors and estate taxes. But there are some risks is using SLATs that need to be explored. Those risks including premature death of a spouse, divorce and something known as the “reciprocal trust doctrine” will be explored in part three of the series.

SLAT Series

couple in mid-60s looking at a laptop.

Separation of Legacy Assets from Lifetime Assets

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.

READ MORE about
older couple preparing food in an upscale kitchen

SLAT as a Planning Solution

This is the second article 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.

READ MORE about SLAT as a Planning Solution

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.