The New Era Of Dynasty Trusts For Estate Planning

Dynasty trusts are making a big comeback under the 2001 tax law for Estate Planning . Before the estate tax was enacted many years ago, dynasty trusts were the standard way to ensure family wealth was preserved and grew through several generations. Now, with the estate tax being phased out more families can emphasize the non-tax goals of estate planning. These goals include wealth preservation, creditor protection, multi-generation investment management, and value-based distributions. The dynasty trust is the ideal vehicle to achieve many of these goals.

A dynasty trust is very flexible. Its terms can be set to meet the goals of an individual estate owner. The trick these days is to shift gears from emphasizing tax savings to considering broader goals for the family and the wealth.

The trust can be set up during the creator’s lifetime or in the will. Most often it is started while the creator is living. With the lifetime estate and gift tax exemption rising to $1 million on Jan. 1, 2002, a large tax-free dynasty trust can be started right away. A married couple can put up to $2 million tax-free into the trust if neither spouse has used his or her lifetime exemption. Additional amounts can be put in the trust as the lifetime exemption rises through 2009.

Even better, the generation-skipping tax is scheduled to be repealed. Because of that tax, before the 2001 tax law dynasty trusts generally could be created only with life insurance.

The tax-free lifetime funding of the trust can be increased through the use of gift tax-slashing strategies such as the intentionally defective trust, installment sales, shifting economic opportunities to the trust, and other shrewd moves. I’ve covered these estate planning strategies in past visits and most are in the archive section of the web site. We won’t cover them in detail this visit. But you should be aware that there are ways to increase the amount of after-tax wealth you can transfer to the trust.

Typically just one trust is created during the creator’s lifetime. After that, the trust often is split into different trusts for each child of the family. Other options are to maintain one trust with subtrusts for accounting purposes. After a child dies, that trust or subtrust often is split into separate trusts or subtrusts for each of his or her children. Or there can be one trust all family members share. As I said, the dynasty trust is very flexible.

The trust is irrevocable, which produces the estate and gift tax savings. Many states also allow the trust to be written in a way that will protect the wealth from creditors of the creator and of the children.

The amount of wealth that can be added to the trust after the creator’s death depends on the size of the estate and the tax law in effect at the time. Your will should have several contingency clauses, so that additional wealth will be added only if the tax cost is reasonable. Whatever happens with the tax law, once the trust is created during your lifetime it stands as a pool of assets exempt from further estate and gift taxes.

After the trust is created, there are many options for its operation. You determine the operating rules when the trust is written, so give the options a lot of thought.

The classic operation is for the trustee, or a group of trustees, to have discretion to make distributions of income and principal to family members. The creator might leave a statement of principles that would guide the decisions. But the actual amounts would depend on a vote of the trustees.

An option that became more popular in recent years is to have distributions based on goals or values, or a combination of the two. We’ve covered these in past visits. For example, distributions might be made for a beneficiary’s education and living expenses until age 21. Subsequent distributions might depend on the beneficiary graduating from college or staying employed. One-time distributions of principal might be made when other milestones are met, such as reaching a certain age. Some trusts increase distributions upon marriage. The distribution formula might make adjustments for those who do charitable work or enter lower-paying, service-based occupations. The choices are limited primarily by your goals and imagination.

A more recent, creative estate planning approach is to have the trust make few formal distributions. Instead, the trust will buy items or make investments for the use of the beneficiaries.

The beneficiaries would be expected to pay for their basic living expenditures from their jobs or businesses. These expenses would include food, schooling, clothing, cars, vacations, and other consumable items. The trust would acquire for the beneficiaries to use assets that are anticipated to increase in value. Such assets could include houses, artwork, jewelry, businesses, and vacation homes. If a beneficiary wants to start or buy a business, the trust could make the investment and let the beneficiary operate it.

A potential disadvantage is that the dynasty trust is irrevocable. The family would be locked into an inflexible arrangement until the trust expires. One way to avoid that is to give the oldest beneficiary of each line a broad power of appointment that essentially would allow him or her to rewrite the trust. You might not believe this is necessary, because once the trust is created the wealth should avoid future taxes even if the law changes.

The new tax law gives families an opportunity to safeguard assets for several generations instead of looking for the lowest tax way to pass assets to the next generation. You can broaden your estate planning focus to providing for several generations and use a trust to protect the wealth from creditors and waste. It’s worth taking a fresh look at the dynasty trust.