The phrase "dynasty trust" typically refers to a trust which will remain in existence for multiple generations. The creator of the trust (sometimes called the grantor or trustor) gives property to a trustee and directs that trustee to hold and manage the money for the benefit of certain people (typically the descendants of the grantor). So that the trust will last a long time, the grantor typically directs the trustee to distribute only the income of the trust to the beneficiaries until the end of the trust term. At the end of the trust term, the grantor directs the trustee to pay the principal of the trust to the trust beneficiaries. A dynasty trust might also give the trustee discretion to distribute principal earlier, but inform the trustee that the grantor's intent is to preserve principal for future generations.
State Law Limitation: Rule Against Perpetuities
Many states limit the duration of trusts. The limitation is imposed by the rule against perpetuities.
The common law rule against perpetuities would allow a trust to last as long as 21 years after the lives of the people named as beneficiaries of the trust at the time it is created. Some states have a modified rule against perpetuities. For example, Georgia will allow trusts to last the longer of 90 years or the period allowed under the common law rule.
Other states, however, have modified the rule to allow for long term trusts. For example, Florida can be a good option for long term dynasty trusts because the Florida rule against perpetuities allows trusts to remain in existence for 365 years.
The state of New Jersey recently eliminated the rule against perpetuities altogether, so trusts created and domiciled in New Jersey can last indefinitely. Some other states have also eliminated the rule against perpetuities
Created During Lifetime or at Death
A dynasty trust could be created during life. Such a trust would be called an "irrevocable inter-vivos" dynasty trust. Someone who wishes to fund the trust with a life insurance policy will also choose to create a lifetime trust to hold that policy because of the ability to leverage the GST exemption to the smaller amount of premiums paid.
A dynasty trust can also be created as a testamentary trust (one created at death). This would be accomplished by including the terms of the testamentary trust in your will or revocable trust agreement.
Transfer Taxes: Estate, Gift, and Generation Skipping Transfer Taxes.
Transfers of property to a trust are subject to federal transfer taxes such as gift and estate taxes. Some states also impose transfer taxes on transfers to trust.
If one makes an inter-vivos gift to a trust, that transfer is subject to the federal gift tax (and possibly state gift tax). As the law stands as of the date of this legal guide in 2009, Individuals have $1 million of lifetime credit which they may use to make transfers to others (including trusts) without actually paying gift tax. A gift to a trust would, in many cases, require the filing of a federal gift tax return. Because a dynasty trust typically pays to future generations, the grantor of the trust should also allocate generation skipping transfer tax exemption (individuals have $3.5 million of GST exemption as of the date of this guide) to the trust so that future distributions will not be subject to generation skipping transfer tax.
If the trust were funded at death, the estate tax would apply.
Income earned by the dynasty trust will be subject to state and federal income taxes each year. For this reason, many grantors will establish the trust under the laws of a state which imposes no state income tax on trusts. The trustee of the trust must file a federal fiduciary income tax return (Form 1041) each year, and may be required to file one or more state income tax returns for the trust, depending upon the location of the assets owned by the trust.
Selecting a Trustee
Because a dynasty trust is intended to last multiple generations, it is virtually impossible to name individual trustees to manage the trust indefinitely. For this reason many grantors choose a corporate or institutional trustee to manage the trust (or at least choose a corporate trustee as a successor trustee). Another reason many dynasty trusts have corporate trustees is because of the rules pertaining to the domicile of a trust. Unless you live in a state which permits long-term trusts or has abolished the rule against perpetuities, you may need a trustee domiciled in another state to manage the trust. State income taxation of trusts also impacts the trust, so many grantor's will select a state which imposes minimal or no taxes on trusts.
Irrevocable; Consider Terms Carefully
Because a dynasty trust will be in existence for a long time, it is vital that the grantor consider carefully what the goals and purposes of the trust are. In addition, the grantor should also consider either giving the Trustee considerable discretion (paired with some guidance on the grantor's intent) or giving individuals (e.g., the beneficiaries of the trust) limited powers of appointment or otherwise give them the ability to guide and direct the trust. Something that makes sense today may not be prudent in 10 years, much less 300 years. Therefore it is important when considering a dynasty trust to seek competent legal and advice from advisors (often including attorneys, accountants, financial advisors, life insurance agents, charitable advisors, and others) before creating a dynasty trust.
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THIS COMMUNICATION DOES NOT CREATE AN ATTORNEY-CLIENT RELATIONSHIP AND DOES NOT CONSTITUTE LEGAL ADVICE. THIS LEGAL GUIDE IS FOR INFORMATIONAL PURPOSES ONLY.
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