The Dynasty Trust
Tax Savings and More for Generations to Come
Changes in the laws of a number of states, combined with the possible, though unlikely, repeal of the federal estate tax and/or the generation-skipping tax (GST), has created a need for a reexamination of the use of Dynasty Trusts. While the term "Dynasty Trust" can refer to a number of different trust forms, it generally applies to those trusts designed to last for multiple generations. Currently, Dynasty Trusts are used most often for tax avoidance purposes. However, in this shifting landscape of trust and tax law, other benefits of the Dynasty Trust, such as gift tax avoidance, asset protection, flexibility, continued control and increased economic benefits, make the Dynasty Trust a more and more desirable technique.
Dynasty Trusts are usually created in states that have repealed or altered the Rule Against Perpetuities, a common law rule that limits the time period for which a trust may last. Elements of the Rule date as far back as the Roman Empire. Its purpose is to prevent property from being tied up indefinitely. Some states (including Arizona, Maine, New Hampshire and Rhode Island), by abolishing or altering the Rule allow perpetual trusts (trusts which may last forever). Other states allow trusts to last for an extraordinary long period of time, though not forever. These states have placed limits of anywhere from 150 to 1,000 years on the time a trust is allowed to exist (for instance, Florida has a 360 year limit). The move to weaken the Rule is a result of a number of motivations, such as a desire in the acting states to enhance the favorability of trust laws to attract out-of-state investments. In addition, an emphasis in the law on land as the sole form of wealth has somewhat lessened, as many people now hold property in a variety of forms, such as securities. These different forms are, for the most part, unaffected by issues related to perpetuity. With the descent of the Rule in many states, practitioners are more easily able to create trusts designed to last far into the future.
A Dynasty Trust, because of its indefinite nature, requires a great deal of sophistication and flexibility. Dynasty Trusts must be ready to withstand innumerable and unpredictable changes in the law, as well as an array of unpredictable personalities that will one day be trustees and/or beneficiaries. Practitioners need to be aware of a number of potential issues that may arise when engaging in this kind of forward-looking planning, and should consider and include the appropriate provisions necessary to maximize flexibility. Such provisions might, among other things, segregate functions between different trustees, grant trustees the power to amend when changes in the tax law occur and grant trustees the power to sever, merge and terminate trusts.
As previously stated, the primary purpose of Dynasty Trusts is to avoid and limit taxation on transfers of wealth over multiple generations of beneficiaries. The idea of permanently abolishing the federal estate tax and/or the GST (the tax on transfers to beneficiaries in the generation not immediately below the transferor, for example, from a grandparent to a grandchild) is often touted by politicians. However, the likelihood that the United States government will permanently repeal these taxes seems highly unlikely, though it is unclear in what form they will exist in the coming years. In other words, the talk of a repeal of both the estate tax and GST is simply that, talk. Thus (and generally speaking), the Dynasty Trust, as with other forms of trust, is one mechanism for transferring assets to beneficiaries free of a wealth transfer tax. Of course, it is possible that the estate tax and GST will one day be repealed. That elimination, would, on its face, appear to decrease the need for trusts as part of one's estate plan. However, many concerns, other than the estate tax and GST, can still best be addressed by the creation of a Dynasty Trust.
One major benefit of the Dynasty Trust is that it can be used to avoid the gift tax, which taxes gifts made during one's lifetime. Distributions made from a Dynasty Trust are not taxable gifts. Therefore, a Dynasty Trust can be established and funded, with distributions being made at the discretion of the trustees to the beneficiaries, for generations, entirely free of gift taxation. Furthermore, a limited power of appointment (which is a power of disposition) can be given to the beneficiaries to make gift-tax-free-distributions whenever they so choose. As a result, the Grantor's beneficiaries are able to enjoy and benefit from the Dynasty Trust, free of the gift tax that otherwise would be applied.
Take the basic scenario, for example, of a person who leaves money to his grandson, who in turn keeps the inheritance and then later in life wishes to give that same money to his own grandson. The portion of that gift above $5 million (the current exemption) will be subjected to the gift tax. In comparison, if the original person had instead established and funded a Dynasty Trust, the same inheritance amount, now held in trust, could be distributed by the grandson to his own grandson free of the gift tax. The grandson would be authorized to do so by the limited power of appointment granted to him by the terms of the Dynasty Trust.
Dynasty Trusts have other benefits beyond saving taxes. For instance, a Dynasty Trust can include a spendthrift provision that prevent a beneficiary's creditors (or spouses and ex-spouses) from reaching the trust assets. Also, a Dynasty Trust can be drafted to allow trustees to purchase real estate for the use of a beneficiary, invest in a beneficiary's business venture and make loans to a beneficiary. The trust can include provisions allowing for the creation of a separate supplemental needs trust for the benefit of a disabled beneficiary, that preserves trust assets and ensures a better quality of life, while at the same time allowing them to qualify for government benefit programs. Furthermore, Dynasty Trusts can be drafted so that distributions are required to follow guidelines created by the Grantor, so that the trust assets can be used only for specific purposes (education, healthcare, etc...) and are prohibited from being used for other activities (such as gambling or freeloading off of the trust). Finally, by holding assets in a Dynasty Trust, more investment opportunities become available that might not otherwise have, and returns on any investments, with a larger initial investment, will in turn be greater. The result is more revenue will be generated, creating greater benefits to beneficiaries that an outright distribution would otherwise not have afforded.
Often practitioners find that trusts, in comparison to outright gifts, are seen as impediments and not worth the time and energy by some beneficiaries. However, Dynasty Trusts can be structured to alleviate administrative burdens and provide a great deal of control to trust beneficiaries. For instance, the trust can define roles to be filled by beneficiaries or grant beneficiaries limited powers of appointment. In doing so, beneficiaries are given the ability to control investments, replace trustees, serve as a co-trustee and authorize distributions (just not to themselves). As a result, beneficiaries have control over trust assets to almost the same level as if the assets were held outright, while at the same time receiving the tremendous tax savings Dynasty Trusts offer.
Dynasty Trusts, in the right situation, offer immense estate tax, GST and gift tax savings as well as the added benefits of asset protection, a great deal of control for beneficiaries and increased economic potential. Even if the estate tax and GST are totally repealed (the likelihood being slim), Dynasty Trusts, as with other types of trusts, will still have purpose beyond simply wealth tax avoidance (despite the misconception that the use of trusts will plummet). Dynasty Trusts are an excellent tool and planning strategy to preserve and optimize assets for the benefit of generations to come.