Multi Generational Perpetual Trusts - Dynasty Trusts

What is a dynasty trust?

A dynasty trust is a long-term trust designed to avoid estate and gift taxes while benefiting multiple generations. Using the basic trust concept of separation of legal and beneficial interests, a dynasty trust can benefit descendants without being included in their estates for transfer taxation purposes.

How long have dynasty trusts been around?

Since the early 1900s, wealthy families like the Rockefellers, Fords and Carnegies have used trusts for multiple generations to help preserve their wealth. Because of the ancient “rule against perpetuities,” such trusts were able to survive for no more than 21 years beyond the death of the last beneficiary alive when the trust was written [commonly a grandchild of the settlor].

What is behind the recent popularity of the dynasty trust? 

Several states, including South Dakota in 1983, have adopted statutes revoking the rule against perpetuities, and allowing dynasty trusts to survive beyond those limitations for a theoretically unlimited duration.

What other advantages does South Dakota offer as a situs for a dynasty trust? 

No state income tax on trusts and a self-settled asset protection trust rule. In addition to eliminating the rule against perpetuities, South Dakota has enacted, and continues to update, a favorable trust regimen in general, with a modern trust code, no state income tax on trusts, and a self-settled asset protection trust rule.

Must the settlor of the trust be a resident of South Dakota?

No, the benefits are available to non-resident settlers. The requirement is that the trustee be a South Dakota resident and that South Dakota law apply to the trusts. In addition, administration of the trust and custody of the assets should have as many South Dakota contacts as possible.

What is the catch?

Congress recognized that dynasty trusts were escaping federal estate tax, and enacted the generation skipping transfer tax [GSTT] in 1986. Assets in excess of the applicable GSTT exemption will be subject to the GSST tax if they pass to grandchildren or more remote descendants, regardless of whether the transfer is outright or in trust

What is the financial benefit of a perpetual or dynasty trust?
For most families it saves taxes. Specifically, as family wealth is passed from one generation to the next, there can be federal estate taxes dues on the assets transferred to each succeeding generation. If a trust of $5.34 million is passed through 3 generations, the cumulative total of estate taxes paid could reduce the value of asset available to the fourth generation by over$197 million or 70%. On the other hand, if the assets we left to a perpetual trust to benefit multiple generations, there would be no estate taxes at each generational change as the trust would just continue distributing benefits to the 2nd, 3rd and 4th generation beneficiaries.This illustration dramatically demonstrates the millions of dollars in benefit to the beneficiaries of the perpetual trust as compared to the same assets passed through normal estates at each generation.

What about gift taxes?

A dynasty trust created during life will be subject to gift taxes, but the lifetime gift tax exemption can be applied to the trust at funding, leaving only the excess subject to gift tax

How can the tax advantages be leveraged?

Maximizing use of the GSTT exemption to create a dynasty trust may significantly reduce taxes on wealth transfers to multiple generations. Funding the trust with assets that are expected to appreciate will insulate the original gift and all of its future growth from transfer taxes.

How can a trust drafted today meet the contingencies of the future? 

Dynasty trusts need to be drafted with maximum flexibility to meet changing circumstances. General provisions such as broad trustee discretion to make distributions, limited powers of appointment for descendants, and trustee power to amend the trust to take advantage of future laws can provide some flexibility. The South Dakota Trust Code includes several sophisticated flexibility-enhancing provisions such as the use of Trust Protectors, a directed trustee statute, and the ability to decant discretionary trusts into different trusts.

Who should be the trustee of a dynasty trust?

The risk of a beneficiary/trustee having so much control that assets are included in his/her estate is of particular concern when trying to achieve the estate-tax leveraging benefits of a dynasty trust. A corporate trustee has significant advantages in a dynasty trust. A corporate trustee located in a state with favorable trust laws is able to provide the situs for the trust. The long duration of the trust also favors a corporate trustee, with its perpetual existence. The expertise in this complex area of the law and the impartiality of corporate trustees provide other advantages

What are the steps to create a dynasty trust?

A dynasty trust is a planning tool and sophisticated estate tool, and requires an experienced drafting attorney.