Dynasty trusts can provide security for generations
Pooling family resources offers several advantagesApril 24th, 2014
Thanks to lengthening lifespans and changing family structures, many families are relying on pooled resources to address multigenerational financial issues. Adult children may be paying for their parents’ long-term care, while in other cases grandparents are pitching in to help their grandchildren pay for college, buy a house, or start a new business.
Concerned that future generations may not be able to count on the same opportunities for financial success as their parents and grandparents, families are looking increasingly for ways to make their money last through multiple generations.
A dynasty trust can be an effective vehicle to allocate a family’s pooled resources for multiple generations that sets clear expectations, minimizes the friction that often surrounds informal family loans and gifts, and optimizes tax outcomes.
Choosing how much wealth to leave to your heirs is a very personal decision. Many people want to keep their assets in the family for as long as possible rather than giving them to charity or seeing them eroded by taxes.
Others, however, feel strongly that each generation should make its own way in the world without relying on inherited wealth. Only you can find the right balance based on what you think will help your descendants succeed without stifling personal motivation and turning them into the proverbial trust-fund babies.
If you believe that financial assistance can enable younger generations to take advantage of opportunities that might otherwise be out of reach, or if you simply want to provide a safety net that will ensure your descendants’ financial security in the event of an emergency or illness, a dynasty trust could be the answer.
A dynasty trust offers many benefits, including tax minimization, asset protection, and exceptional flexibility in determining the structure of trust distributions.
Dynasty trusts are long-term trusts that transfer wealth from generation to generation without incurring transfer taxes such as estate and gift taxes.
The assets are subject to federal estate and gift taxes only when you place them in the trust, not when each future beneficiary receives a trust distribution. Thus, the magic of compounding allows the fund to distribute considerably more than it would be able to if it were subject to taxation at every step—and this benefit grows the longer the trust lasts.
While the trust is subject to federal income tax rules, you can pick a state jurisdiction with favorable income tax rules, such as Washington, to minimize the total tax bite and increase the compound returns over the long life of the trust.
The old common-law “rule against perpetuities,” prohibiting trusts that can last forever, specifies that a trust can operate for just 21 years after the death of the last beneficiary who was alive when the trust was established. Some states, however, have changed the legal limits—Washington, for example, allows trusts to operate for 150 years—and others have abolished the rule entirely.
If you want to establish a trust that lasts forever, you can set it up in one of the states that allows this, even if you aren’t a resident there, as long as you meet certain criteria such as naming a trustee that operates in the selected state or having the assets administered in the selected state. Your financial planner can help you assess the tax implications of the various options.
In addition to protecting accumulated wealth from estate and other transfer taxes, dynasty trusts can protect assets from claims by your beneficiaries’ creditors and ex-spouses, as well as from potential mismanagement by beneficiaries themselves.
Like most other types of trusts, dynasty trusts include a spendthrift clause that prevents both voluntary and involuntary transfer of the beneficiary’s interest in the trust. The provision prohibits trust beneficiaries from transferring their interest in the trust to third parties and prevents creditors from attaching a beneficiary’s interest in the trust before he or she has received the actual distribution.
If you have a large estate, you likely won’t transfer all your assets to a dynasty trust (you can, but the taxation issues change). You can maximize the tax result by limiting the amount you transfer to no more than the generation-skipping transfer tax exemption, which for 2014 is $5,340,000 per person.
Dynasty trusts aren’t just for the extremely affluent, however; their flexibility allows many different types of families to protect their assets while helping future generations become successful and productive members of society.
Combining the estate and income tax leverage and the longer life of the trust with the use of life insurance as a funding vehicle, for example, can further contribute to the ultimate size and growth of the fund.
You have a great deal of control and flexibility in setting up a dynasty trust.
A lawyer who specializes in establishing trusts can help you draw up the terms that will govern the trust distributions.
The trustee—usually a bank or trust company—that you appoint to manage the trust and invest the trust assets will be in charge of making the distributions according to these terms.
You can use the trust terms, in the form of incentive provisions, to promote the transfer of family values to successive generations. If you want to encourage initiative and prevent your beneficiaries from becoming dependent on the trust, for example, you could provide incentives for accomplishments such as graduating from college, starting a business or building a home, without providing full support.
You also could direct the trustee to take into account the beneficiaries’ other resources in making trust distributions.
If you want to encourage service and a sense of purpose, you could supplement the incomes of descendants who choose to work in fields that are valuable to society but not particularly well paid, such as teaching, social work, or other service professions.
You can include a charity as a trust beneficiary in case your heirs don’t use all the funds, or you could encourage your descendants to engage in charitable giving themselves—for instance, by offering a matching distribution equivalent to a certain percentage of the charitable donations they make during the year.
The terms of the trust can be as general or as specific as you wish, enabling you to tailor the trust to your particular situation and priorities.Keep in mind, though, that a dynasty trust is irrevocable, so neither you nor your heirs will be able to alter the terms of the trust if circumstances change.
In short, a dynasty trust enables you to provide long-term financial security for future generations by minimizing transfer taxes and maximizing what your descendants receive, while at the same time protecting assets from beneficiaries’ mismanagement or creditors’ claims.
A dynasty trust is flexible, as it allows you to define the terms in as much detail you wish.
You can decide when and why your beneficiaries should receive trust distributions, and how much these distributions should be.
Talk to your financial adviser if a dynasty trust sounds like a good fit for your needs. Structured correctly, a dynasty trust can help you leave a lasting legacy that provides security to multiple generations of family members.
J. Todd Edmonds, vice president, trust officer, and Spokane branch manager with D.A. Davidson Trust Co., has more than 30 years of experience in all aspects of trust services. He can be reached at TEdmonds@dadco.com or (800) 676-8323.