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Typical estate tax trust planning stipulates that upon the death of the surviving spouse, everything is passed to the children in equal shares. For larger estates, however, it is highly advisable to continue to hold assets in trust for the benefit of the children (or other beneficiaries) for their entire lifetimes.
This type of approach is often referred to as a “dynasty” trust as the trust is designed to provide benefits to the children’s generation and then continue down to the grandchildren’s generation. The benefits to be gained from this type of approach are incredibly valuable, while the cost in terms of restrictions on the children’s access to the money is really minimal.
Advantages Of Dynasty Trusts
By leaving the assets in trust for the children for their lifetimes, creditor protection can be provided to them. Everything in the trust can be protected from the claims of creditors, whether those creditors arise in business transactions or in a lawsuit for negligent harm to another. The legal theory is that the beneficiary (each child) does not own the assets of the trust and, therefore, his creditors cannot reach those assets. Because the beneficiary himself cannot withdraw the trust assets on demand, neither can his creditors.
Another plus for keeping assets in trust for the children is that at their own deaths someday the assets will not be taxed in their estates, thereby saving as much as 50% of the amount remaining. Such estate tax savings can be very valuable to one’s children when it comes time for them to plan their own estates.
Protection From Divorce
Another advantage of keeping assets in trust for the lifetime benefit of the children is that the trust assets can be protected against a spouse in the event of divorce. A spouse is treated much as is any other creditor, and if the child cannot demand the assets from the trust neither can a spouse who sues that child for divorce. (Note that a judge in a divorce action may take into consideration the existence of the trust in dividing the marital assets between the child and his spouse, perhaps giving more of those marital assets to the spouse, but the trust assets will remain protected.)
For some, a further advantage of keeping assets in trust for the lifetime of the children is that upon their ultimate deaths, the parent can control where those assets will go, e.g., requiring that the assets pass to the grandchildren rather than to the child’s spouse. To build in flexibility, if so desired, it is possible to give the children the power to decide the disposition of the assets under their own will (through a “power of appointment”), that power can be limited so that only the parent’s descendants (and/or the spouses of those descendants) will be entitled to those assets.
Despite this creditor protection, however, the beneficiary (each respective child of his own share) will have the right to as much income and principal as the trustee deems advisable (that discretion in the trustee is the secret to creditor and tax protection).
Each child could also have the power to distribute any of the trust at any time to his own children and/or perhaps to his spouse, depending on how the parent would want it designed. Each child could have the power to dispose of his trust share under his will (again limited within whatever class of people the parent directs).
Finally, each child might also have the power to withdraw 5 percent of his trust principal each year without the trustee’s permission (although that power is not necessary, and tax wise it is generally better not to have it).
Thus, even though the trust assets will be retained in trust for the child’s lifetime, the limitations on his access to the assets would be minimal, although a trustee’s permission may be needed. To give the children even more practical control, the children can have the power to remove a trustee and have another appointed in the event the trustee became uncooperative and unreasonable.
Generation Skipping Tax
As indicated above, an additional benefit of this “dynasty” trust for the lifetime of one’s children is that the assets in the trust will not be part of the children’s own estates at their own deaths someday. For federal purposes, there is the “Generation Skipping Tax” with which one must contend. Upon the deaths of each child, the federal government would want to impose this generation skipping tax. (The generation skipping tax is essentially an alternate estate tax on assets that the actual estate tax otherwise cannot reach.)
Despite this generation skipping tax, however, there is an exemption that one can utilize. That exemption is $11,580,000 (for 2020) for each transferor (increasing in accordance with the increases to the estate tax exclusion amount hereafter). The way it works is that the sum of $11,580,000 can be set aside by each person at his or her death, such amount to be forever exempt from the generation skipping tax.
Whatever that $11,580,000 (or a combined $23,160,000 for a married couple) grows to will always be exempt so that one’s family could be dealing with very large amounts of estate-tax-exempt assets by the time the children die. The amount in excess of the generation skipping tax exemption could also be placed in trust for the children, but it would someday be subject to a generation skipping tax when they die.
Nevertheless, these nonexempt assets would be the main source of funds on which they would live during their lifetimes, perhaps leaving no taxable assets by the time they die. The exempt portion of what is given to the children would continue to grow in a separate trust for the ultimate tax-free distribution to their own children someday, to the extent the children did not need to spend it.
Explore Your Options For Dynasty Trusts
When the division and distribution of funds are involved, legal advice from a seasoned professional is invaluable. With over three decades of experience serving Massachusetts residents, Fedele and Murray, P.C., can help you determine whether a dynasty trust fits your unique personal and financial situation. Reach out to us online or by phone: 781-551-5900.