Understanding Dynasty Trusts

Although recent tax law changes call for the gradual reduction and eventual elimination of estate taxes in the coming years, estate taxes are still a very real planning obstacle for many affluent families and individuals. Therefore, careful planning is still the best way to reduce estate taxes and maximize assets transferred to heirs.

In the absence of an adequate plan, heirloom property or a family business that involved a lifetime of hard work may have to be sold to satisfy tax obligations. Fortunately, there are several unique planning mechanisms that can help individuals maintain wealth for generations to come. One such tool is the dynasty trust.

Gaining Perspective
A dynasty trust, also known as a family bank or family trust, is a form of trust that can help reduce estate taxes and also provide control over how trust assets are distributed to future generations. With a dynasty trust, you control who the money goes to and in what amounts over an unlimited amount of time, without limitation by the rule against perpetuity.

The rule against perpetuity dates back to English law and states that an irrevocable trust may not last longer than the life of the living beneficiaries at the time the trust is created, plus 21 years. The application of the rule against perpetuity varies from state to state, which underscores the need for qualified legal and tax professionals with expertise in estate planning when contemplating a dynasty trust.
A dynasty trust is established by combining a trust with a limited liability company (LLC) or a family limited partnership. You and your family then transfer cash or other assets to the trust, either all at once or annually.

Funding the trust may trigger gift taxes. However, these rates are lower than estate tax rates and are based on current asset values. In addition, gifts that are properly structured may also receive a discount for gift tax purposes. The trust agreement will specify the trust’s beneficiaries, the conditions under which they receive income and/or principal, provisions for loan arrangements to beneficiaries, the term of the trust, and the distribution of trust assets at termination.

Stretching Out Benefits
One of the main tax advantages afforded by a dynasty trust is the generation-skipping transfer (GST) exemption. The GST is $1,500,000 per transferor for 2004 ($3,000,000 for married couples), applied to the value of assets at the time they are transferred into the trust.

Creating your own “family bank” can be a very tax-cost effective way to leave a substantial legacy for many generations to come. It allows you to designate how much, when, and under what circumstances your heirs will receive income, principal, or both. It can also ease worries of a future heir squandering an inherited lump sum. You can establish specific conditions that beneficiaries must meet in order to receive funds, and you may also include incentive programs that reward the achievements of heirs.

A dynasty trust can be a powerful estate planning mechanism for efficiently transferring wealth to future generations. However, keep in mind that like all estate planning matters, dynasty trusts are complex and require qualified legal and tax counsel to draft and execute.

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