Many families want to use their wealth to provide not only for their children, but for future generations as well. One of the most powerful tools available to help them do that is the Dynasty Trust. Properly structured, a Dynasty Trust can ensure your assets will not be included in your or your descendants’ estates, so they can pass tax-free from one generation to another.
Dynasty Trusts are available in all states, but the laws in many states subject these trusts to the "Rule Against Perpetuities," which forces trusts to end roughly 80 to 110 years after they are created. But currently 13 states, including Illinois and Wisconsin, have legislation that does not limit the duration of a Dynasty Trust. People throughout the U.S. can establish and maintain trusts in these states that can continue until all of the trust’s funds have been distributed or until the last living descendant of the creator of the trust dies. The individual creating the trust doesn’t need to be a resident of either state to benefit so long as the trust has some connection with the state, such as the trustee being located there.
What is a Dynasty Trust?
A Dynasty Trust is designed to hold assets in trust without direct ownership being transferred to any beneficiary. Instead, successive generations would receive the income those assets generate, or the income is added back into the principal of the trust, allowing for future growth. For transfer tax purposes, the trust's assets are valued at the amount they were worth when the trust was created so as long as the assets stay in the trust. Any appreciation is exempt from estate taxes.
Besides keeping future asset appreciation undiluted by transfer taxes, there is another advantage to creating a trust today, during your lifetime, as opposed to through your will. The protections and exemptions that exist now may change—there is no guarantee the laws and exemptions that exist currently will be the same by the time the trust is created through your will.
An additional benefit to the Dynasty Trust is that since the trust's assets do not belong to any of the beneficiaries, the assets cannot be subject to claims of creditors or ex-spouses. Plus, a Dynasty Trust established in Illinois by a person who is a resident of another state generally is not subject to Illinois taxes; although in some cases it might be subject to taxes in the trust creator's home state.
Leveraging Tax Exemptions
Recognizing the fact Dynasty Trusts allowed wealth to escape the federal tax system, in 1986 Congress enacted the generation-skipping transfer (GST) tax to recapture that lost income. Now, assets in excess of $1 million that pass to a trust grantor's grandchildren and future generations are subject to taxes, whether or not they are part of a trust. However, if you use that $1 million exemption to create a Dynasty Trust, the income derived from the trust's assets will be distributed free of the GST tax for the duration of the trust. (A married couple can "pool" their exemptions and create a $2 million Dynasty Trust.) Without the exemption, the 55% GST tax is assessed in addition to gift or estate taxes—not to mention state taxes — so federal taxes alone can wipe out more than 75% of transferred assets within only two generations.
Maximizing use of the GST tax exemption when creating a Dynasty Trust can significantly reduce taxes on wealth transfers to individuals more than one generation below that of the creator. Working with a knowledgeable estate planner or GST tax return preparer, the creator simply needs to allocate his or her GST tax exemption to the Dynasty Trust.
Gift taxes also still apply when creating a Dynasty Trust, but you can apply your $1,000,000 lifetime gift and estate tax exemption to the assets being given to the trust. Therefore, if you've funded the trust with more than $1 million, you'll only pay gift taxes on the amount over the $1 million exemption. The gift tax you pay is deducted from your overall estate (unlike estate taxes), thereby reducing the amount of taxes paid at your death.
While $1 million may not appear to be a considerable amount, an individual can fund the Dynasty Trust with assets that will appreciate in value, such as stock or interests in a new business. This strategy also keeps asset growth out of future generations' estates.
Selecting a Trustee
Choosing the right trustee is particularly important for Dynasty Trusts for several reasons. A corporate trustee like Northern Trust can provide a connection to a state that offers perpetual Dynasty Trusts, alleviating the need for a family member or beneficiary to have to live in the state in order to take advantage of a Dynasty Trust.
And, because Dynasty Trusts can continue indefinitely, a corporate trustee typically is the best choice because an individual would not live long enough to carry out the trust's provisions. A corporate trustee offers other advantages:
In addition, an independent corporate trustee can help prevent tax liability, because a beneficiary who is also a trustee could be found by the IRS to have some level of control over the trust—which could then lead to adverse taxation to the trustee/ beneficiary. While naming a corporate trustee is encouraged, the trust can provide for an advisory committee of one or more family members (other than its grantors), or of other trusted individuals to ensure family involvement.
Building in Flexibility
The trust's structure should be as flexible as possible to protect the grantor and beneficiaries from the unknown. To this end, provisions such as the following can be written into the trust:
Other provisions allow the trustee to distribute income among beneficiaries as appropriate—such as withholding distributions from a beneficiary with creditor or marital problems, or increasing distributions to descendants who need to supplement their incomes.
Creating a Dynasty Trust
Dynasty Trusts are sophisticated estate planning tools that involve complicated issues of federal tax law, as well as state trust law. Nevertheless, they provide a highly effective way to transfer wealth to future generations with minimal tax consequences. And being exempt from termination rules in Illinois and Wisconsin, they can have even longer-lasting benefits.
How to Find Out More
Learn how to create your own dynasty. Northern Trust's experienced and professional Relationship Managers can help you protect your estate and provide financial security for those you love for generations to come. Contact us for more information.
The foregoing discussion is general in nature and is intended for informational purposes only. Because the facts and circumstances surrounding each situation differ, you should consult your tax advisor, attorney, and estate planning professional before making any changes to your estate plan.
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