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 may receive distributions from trust assets or assets that remain held in trust, allowing for future benefit and growth. For transfer tax purposes, the trust's assets are valued at the amount they were worth when the trust was created as long as they stay in the trust. Any appreciation generally is exempt from estate taxes.
Besides keeping future asset appreciation undiluted by transfer taxes, creating a trust today or during your lifetime offers another advantage: you can benefit from the protections and exemptions that currently exist. Keep in mind, if you wish to create a trust through your will, exemptions and rules may change.
An additional benefit to the dynasty trust is that, because the trust's assets do not belong to any of the beneficiaries, the assets usually are not subject to claims of creditors or exspouses. Plus, if you establish a dynasty trust in Delaware, for example, and are a resident of another state, the trust generally is not subject to Delaware taxes; although in some cases it might be subject to taxes in your home state.
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, statutes in 20 states including Arizona, Colorado, Delaware, Florida, Illinois, Missouri, Ohio, Washington, Wisconsin and the District of Columbia revoke this rule. Individuals 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 trust's creator dies. Some states, however, do limit the duration of dynasty trusts with limits ranging from 150 to 1,000 or more years. The individual creating the trust doesn't need to be a resident of one of these states to benefit as long as the trust has some connection with the state, such as the trustee being located there.
Leveraging Tax Exemptions
Recognizing that dynasty trusts allowed wealth to escape the federal tax system, in 1986 Congress enacted the generation-skipping transfer (GST) tax to recapture lost revenue. Now, assets in excess of $1.5 million that pass to your grandchildren and future generations are subject to taxes, whether or not they are part of a trust. However, if you use that $1.5 million (in 2005, increasing to $3.5 million in 2009) exemption to create a dynasty trust, trust income and principal may be distributed free of the GST tax for the duration of the trust. (A married couple can "pool" their exemptions and create a $3 million dynasty trust.) Without the exemption, the 47% (in 2005, decreasing to 45% in 2009) 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 you. Working with a knowledgeable estate planner or GST tax return preparer, you simply need to allocate your GST tax exemption to the dynasty trust.
Gift taxes also apply when creating a dynasty trust, but you can apply your $1 million lifetime gift tax exemption to the assets being given to the trust. Therefore, if you've funded the trust with $1.5 million, you'll only pay gift taxes on the remaining $500,000. Any gift tax you pay is deducted from your estate (unlike estate taxes), thereby reducing the amount of taxes paid at your death.
While $1.5 million may not appear to be a considerable amount, you 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 a dynasty trust 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 live in the state in order to take advantage of the favorable dynasty trust rules.
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 as well:
- It is a specialist in handling trusts and has investment and tax expertise
- It is impartial free of emotional bias and conflicts of interest with the beneficiaries
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 of 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 can 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:
- Descendants can accomplish specific goals such as graduating from college or attaining a particular earned income level before receiving benefits.
- Independent trustees may amend the trust to take advantage of future tax laws.
- Beneficiaries may be given restricted powers of appointment; that is, the power to change how the dynasty trust is held for the family after their deaths in order to avoid unintended estate tax consequences.
Other provisions allow the trustee to distribute income and principal among beneficiaries as appropriate such as withholding distributions from a beneficiary with credit 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 establishing one in a state without termination rules 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. Call us for more information.
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