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Dynasty Trusts: Passing Wealth Down the Generations

Sponsored by Pacific Advisors


Many families would like to pass their wealth down to their children. In turn, their hope is that their children will be successful and can pass wealth down to the next generation, and so on. Unfortunately, along the way, each transfer between generations gives the federal and state tax authorities the opportunity to levy and collect estate and gift taxes, diminishing what’s actually left. How can you maximize your family’s financial legacy?

Many of the country’s wealthiest families often use a method for transferring wealth that permits the accumulation and distribution of assets to multiple generations with the least amount of taxes. This involves the use of “Dynasty Trusts.” These trusts enable affluent families to benefit multiple generations with a single transfer of property, and to make distributions to descendants for their needs.

At one time in our country’s history, there was no limit to the amount of property that could be left in trust for the benefit of multiple generations of family members. Ultra-affluent families used trusts to avoid the transfer taxes that would otherwise apply when property was transferred down successive generations. Many of the great family fortunes were passed down intact, over long periods of time, in this manner. But in 1986, Congress created the “Generation-Skipping Transfer Tax” (GST tax). The GST tax took away the ability to pass unlimited wealth to successive generations without tax consequences.

The GST tax was designed to protect against the avoidance of gift and estate taxes when property was transferred, either outright or in trust, and either during life or at death, to individuals more than one generation below that of the transferor (for example, a grandparent gifting directly to a grandchild, bypassing the child). The GST tax is complicated in its application and expensive when assessed—currently at a 45 percent tax rate. Although current laws provide an exemption for the GST tax of $3.5 million in 2009, careful planning must be made to ensure transfers fall within the exemption. Dynasty Trusts are designed to take advantage of this exemption.

Dynasty Trusts are even more efficient and impactful when they’re funded with highly appreciating assets or life insurance. Since it’s difficult to predict if assets will continue to appreciate over a long period of time, life insurance is often a better funding vehicle. The reason for this is the leverage that a life insurance death benefit has relative to the premiums that need to be paid. The death benefit is often a significant multiple over the total premiums paid, but it’s the premiums paid that would count toward the GST tax exemption.

The other complicating factor to the use of Dynasty Trusts is that, historically, states have had laws that limited the lifespan of trusts. These laws were called “Rules Against Perpetuities,” and they effectively limited trusts to a term of 90 to 120 years, after which the trust would have to terminate and distribute the balance of principal and income to the remaining beneficiaries. However, starting in the late 1990s, many states began to repeal their respective Rules Against Perpetuities, so it’s now accurate to say a trust can be a true Dynasty Trust. More than half of the United States have abolished or significantly modified their version of the Rule Against Perpetuities. The list continues to grow.

How does it work?

Let’s say “Joe” has expressed an interest in establishing a trust that would let him benefit his family for multiple generations. With the assistance of Joe’s estate planning attorney, a multigeneration Dynasty Trust is created, and he gifts money each year to the trust in an amount that would cover the life insurance that the trust intends to purchase. The attorney instructs Joe regarding some of the technical requirements in making the gift to ensure Joe leverages his GST exemption.

The trustee of the Dynasty Trust purchases and owns the life insurance on Joe’s life and makes the premium payments. Then, Joe, with the help of his tax adviser, notifies the IRS that he’s used some of his GST tax exemption to shield the Dynasty Trust from the GST tax.

Upon Joe’s death, the insurance proceeds will be paid to the Dynasty Trust. The trust assets can continue to be held in trust for the benefit of multiple generations of Joe’s family. The assets continue to grow but the trustee has the ability to make distributions to family members as the trust’s beneficiaries. This can continue in perpetuity.

In this example, the Dynasty Trust is created during Joe’s lifetime. It’s funded with cash to let the trust purchase life insurance on Joe’s life. Joe’s wife could have joined him in his arrangement and the trustee could have purchased survivorship life insurance on their joint lives. Joe could also have gifted other assets, such as securities, that he believes will continue to grow in value. In addition, Joe could have opted to have this trust created at his death, funded with assets held in his estate.

Dynasty Trusts can benefit all sorts of families, not just the wealthy, particularly if their goals include:

•     A desire to provide for multiple generations of family members;

•     An interest in protecting accumulated assets from estate and generation skipping transfer taxes;

•     A concern about protecting accumulated wealth from creditors and ex-spouses; and

•     A desire to ensure the transfer of family values to successive generations in the form of incentive provisions

By creating a Dynasty Trust, families can leverage the available GST tax exemption to shield trust assets from the GST tax; maximize wealth for future generations by leveraging life insurance; and shield assets from tax, which lets the value of trust assets grow even greater than would have been possible had those assets passed directly from generation to generation.

Mick Menendez is a Senior Partner/Director of advanced planning for Pacific Advisors, with more than 35 years of experience in the financial services industry.

The foregoing information regarding estate, charitable and/or business planning techniques is not intended to be tax, legal or investment advice and is provided for general educational purposes only. Neither Guardian, nor its subsidiaries, agents or employees provide tax or legal advice. You should consult with your tax and legal adviser regarding your individual situation.


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