A Dynasty Trust is one that may continue in existence indefinitely. In most states, a Trust can only exist for a certain period of time. Many times this restriction is called the “Rule Against Perpetuities” which requires that a trust must terminate no later than 21 years after the death of the last life in being at the time the trust was created. Example: Eleanor creates a trust for her two children and three grandchildren (the beneficiaries) and she dies soon after. Under the Rule Against Perpetuities, Eleanor’s trust will exist during the lives of her children and grandchildren but it must terminate 21 years after the last beneficiary’s death. Therefore, if Eleanor’s last granddaughter lives for 50 years after the trust is created, the trust will exist for 71 years.
As a matter of public policy, the rule was implemented to prevent wealthy families from a tax free transfer of wealth to successive generations. This New York Times opinion article by Boston College Law School Professor, Ray D. Madoff, provides some background on Dynasty Trusts including the arguments for restricting the lifespan of a trust. A few states have abolished the Rule Against Perpetuities and instead established a time limit for the existence of a trust. Other states such as South Dakota, Alaska, and Delaware have abolished any restriction on the length of trusts and they now allow trusts to exist forever (with some exceptions).
Although, even with the trust friendly legislation passed by states to attract large trusts, the federal government may decide to pass legislation preventing the creation of Dynasty Trusts. As Scott Martin of the Trust Advisor Blog explains in his article, White House Punches Wealthy Again – This Time Dynasty Trusts, we may someday see a federal limit on the lifespan of trusts. Laura Saunder’s recent Wall Street Journal article, Dynasty Trusts Under Attack, covers the likelihood of a federal restriction and what it means for individuals considering the Dynasty Trust as an estate planning tool.
Benefits of a Dynasty Trust
For wealthy families, one main benefit of a dynasty trust is that it can avoid the federal estate taxes that would otherwise be paid at every (or every other) generation. The beneficiaries do not own an interest in the trust assets and therefore the assets are not included in any of the beneficiaries’ estates. Without any estate tax liability, the Trust assets grow exponentially faster than traditional wealth transfer vehicles. The Trust Advisor Blog links to this illustration created by Northern Trust to show the wealth that can be created with a dynasty trust.
Other benefits of the Dynasty Trust are the same benefits available to other types of trusts. For example, most trusts may include language that protects trust assets from the creditors of beneficiaries by use of a spendthrift clause. The trust documents may also instruct the trustee on the type or frequency of appropriate distributions. The instructions can be tailored to a grantor’s specific goals, but these guidelines or incentive provisions are used primarily when the grantor is concerned that a beneficiary lacks the motivation to work or become a contributing member of society. The spendthift clause and the incentive provisions are attractive to families who wish to use trusts. It is the the combination of spendthrift clauses, incentive provisions, and the lack of tax liability that makes Dynasty Trusts so attractive.
One thing is certain, we will hear more about the possible restrictions of Dynasty Trusts as the government looks for additional ways to increase revenue. For the time being, Dynasty Trusts are an excellent way to keep wealth in the family.
