Most Americans would not consider their accumulated wealth sufficient to be worthy of the moniker dynasty, but the use of a Dynasty Trust may be very useful in passing assets to later generations of descendants free from the imposition of estate taxes and the generation-skipping transfer tax ( GST ).
Congress enacted the GST tax in response to trusts that were designed to skip successive generations to avoid estate taxes for the generations who were skipped. The GST tax is imposed upon the transfer from an individual to a third or later generation, such as a transfer from a grandparent to a grandchild or great-grandchild. The exemption for a GST is $1 million for each individual or $2 million for a married couple. The GST tax is not imposed until the later beneficiaries have use of the funds.
The purpose of a Dynasty Trust is to avoid the imposition of estate tax when the beneficiaries of the trust die. A Dynasty Trust is an irrevocable trust in which the children of the maker of the trust are not vested with the right to use the trust property for themselves or which gives them a right to appoint the trust property for successive generations of descendants of the settlor. Because the Dynasty Trust does not allow the maker s children to withdraw funds upon demand, or to appoint the trust proceeds to themselves upon their deaths, the assets in the Dynasty Trust are not included in the taxable estates of the settlor s children. Therefore, there is no estate tax on the Dynasty Trust s assets at their deaths. This is done by taking advantage of the exemption permitted by the GST.
The use of a Dynasty Trust would be ideal where the maker s children already have sufficient assets to live comfortably and are not likely to need the assets of their parents during their lifetimes. Once created, a Dynasty Trust may stay in existence for several generations, during which the value of the trust will not be reduced by estate taxes, thereby permitting the value to compound. The terms of a Dynasty Trust can be designed to permit flexibility in the distribution of income and principal, as well as to protect assets in the trust from claims against the beneficiaries, divorces, and from the financial irresponsibility of the beneficiaries.
One common and inexpensive way create a dynasty is to fund a Dynasty Trust with a life insurance policy. By making the Dynasty Trust the owner of the life insurance policy, the life insurance proceeds will not be taxed in the estate of the maker upon his death, and can be exempt from the GST tax if the amount of the life insurance proceeds is less than the $1 million and $2 million exemption amounts discussed above. In some cases, it may be advisable to fund the Dynasty Trust with amounts greater than the exemption and to have the settlor pay the GST tax. This alternative not only removes the Dynasty Trust assets from the settlor s estate but also reduces the settlor s estate by the amount of the GST tax paid. If you would like to know more about the many uses of Dynasty Trusts, please do not hesitate to telephone us.