Dynasty Trust

PLANNING ADVANTAGES OF A DYNASTY TRUST©2000
By J. Kenneth Harris, Esq. LLM    Harris Law Offices

LIVES IN BEING PLUS 21 YEARS

For most of modern trust history the duration of the trust was limited to some definite period of time. The reason for this was the legal doctrine of the “Rule Against Perpetuities”. The practical effect of this rule is that when a trust is established for the benefit of the settlor’s children and their heirs, somewhere in the trust document is a paragraph that requires the trust to terminate, and the trust assets be distributed, on the earlier of (a) a date 21 years after the death of the last surviving issue of the settlor living at the time the trust was created or (b) the death of the last surviving issue.

DYNASTY TRUST

A number of states, including New Jersey, have repealed the rule against perpetuities. As a result, an individual can establish a trust, assuming it is properly drafted, that can last indefinitely. The popular phrase among estate planners used to describe such a trust is a “dynasty trust.” The purpose of this article is to highlight some of the advantages of using a dynasty trust and provide some drafting suggestions.

MILLIONAIRE HOUSEHOLDS & WEALTH TRANSFER

We have all witnessed the phenomenon of people retiring and finding that in the last 5 or more years their retirement accounts and other stock holdings have grown to the point that they are millionaires. In fact, by 2010 the number of millionaires in the population will grow five to seven times faster than the household population in general and the number of decedents with estates in excess of $1,000,000 will increase by 246%. It is expected there will be 5,600,000 millionaire households by 2005. In addition, we have the current tech and dot.com entrepreneurs who have made their first million by age 30 with the result that they have significant estates of their own and the wealth accumulated by their parents may not be essential to maintaining their lifestyle. Under this scenario the dynasty trust becomes an outstanding method to preserve family wealth for future generations.

ADVANTAGES OF THE DYNASTY TRUST

What does the dynasty trust do? First, it insulates the funds placed in the trust from federal estate tax at the settlor’s death and the death of subsequent beneficiaries of the trust until such time as the principal of the trust is finally distributed at the death of the last beneficiary. The dynasty trust provides for discretionary distributions of income and principal to as many generations as the trust shall last. If we assume that the trust is funded with $1,000,000 (typically it will be funded with an amount up to the maximum available GST exemption of the settlor, which is $1,030,000 for 2000), and earns 5% on an after tax basis, it will be worth $131,501,258 at the end of 100 years. If the same $1,000,000 was gifted from a parent to his/her child and then passed on to the next generation with each generation being subject to a 55% estate tax every 25 years, the value would be $5,392,373.00. Clearly, there are significant tax advantages to using such a trust. Alaska, Arizona, Delaware, Idaho, Illinois, Maryland, New Jersey, Ohio, South Dakota and Wisconsin have repealed or otherwise modified their respective State law with respect to the rule against perpetuities so as to permit perpetual trusts.

Assuming that you want the dynasty trust to be exempt from the federal generation skipping tax, the settlor could contribute up to $1,030,000 in assets to an irrevocable trust. The transfer, up to $675,000 (the current applicable credit amount), would also be exempt from the federal gift tax. If the settlor’s spouse joined in the gift, the maximum amount could be contributed without incurring a gift tax. The GST exemption would be allocated to the trust by timely filing a gift tax return. Once this is done, the assets in the dynasty trust will not be subject to the federal estate tax until their final distribution. Additionally, if a tax friendly jurisdiction is selected, for example Alaska, Delaware or South Dakota, the income of the trust is not subject to state income tax.

An added benefit of the dynasty trust is the asset protection features of such a trust. If the typical spendthrift clause is included in the trust document, creditors of the beneficiaries cannot reach the trust assets, preserving them against the beneficiary’s bad decisions. This may be particularly important in light of the high incidence of divorce during the last 10 or more years.

FUNDING THE GST EXEMPT DYNASTY TRUST

Once the decision has been made to establish a GST exempt dynasty trust, the settlor must decide what assets are to be placed in the trust. Since the maximum value that can be contributed to the exempt trust is limited, assets, which have the greatest chance for future appreciation, are favored assets. One such asset is life insurance. The GST exemption is allocated to the premiums contributed to the trust and when the proceeds of the insurance are received by the trust they are exempt. The relative leverage between the amount of premiums paid/exemption allocated and the proceeds of the policy can be significant. Other good assets are those that are anticipated to appreciate substantially, interests in FLPs or family owned businesses when there is a desire to retain control, and real estate and other assets that will be used by the beneficiaries.

DRAFTING SUGGESTIONS

In light of the fact that the dynasty trust is to last indefinitely, it is essential that its terms provide for unforeseen circumstances. Consequently, it is important to include provisions within the document that will allow removal or replacement of a trustee, change of status of the trust/trust assets, as well as administration or governing law, allocation of principal and income, creation or elimination of powers of appointment, division into separate shares, discretion with respect to distributions and savings clauses. If one or more of the beneficiaries is to serve as a trustee, any distributions from the trust should be subject to an ascertainable standard. In the alternative, if there is an independent trustee, the independent trustee can have complete discretion to distribute principal or income without adverse estate tax consequences to the settlor or the settlor’s beneficiaries. Decisions with respect to investments and distributions might be delegated to a committee composed of the trustees, representatives of the beneficiaries and the beneficiaries.

Further, since the purpose of the trust is to preserve wealth and provide for the accumulation of assets, the trust should have the power to acquire real estate and personal assets, which will be used for the benefit of the trust’s beneficiaries. Finally, there should be discretion to retain income and possibly incur higher income taxes when the trust’s marginal rate is higher than that of beneficiaries.

CONCLUSION

The dynasty trust offers many advantages beyond those available with the traditional by-pass/family trusts or irrevocable life insurance trusts currently used by most estate planners. In those cases where the client has an estate of $3,000,000 or more, the dynasty trust should definitely be considered and, even in smaller estates, its long term advantages and flexibility may dictate the use of its generation-skipping features.