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Should You Create a Dynasty? Part 2

Last month, I wrote about six states which changed their trust laws to allow you to save federal estate taxes until the end of time. No more dreaming about repealing estate taxes! Use one of these state's trusts and those taxes are a thing of the past!

Uncle Sam lets you put up to $1 million into a "dynasty" trust and avoid transfer taxes for as long as the dough stays in the trust. The other 44 states have a "Rule Against Perpetuities" which requires trusts to terminate within about 100 years. At that point, the lucky recipient will have to squander it or, as the IRS likes to think of it, the property comes back into play for transfer tax purposes. Those six states that repealed the Rule permit trusts to last, and avoid estate taxes, forever.

A problem with the typical long term trust is that it must distribute at an arbitrary date without regard to the needs, circumstances or capabilities of the recipient. Go ahead, tell me with certainty what age is the best to inherit a lot of money. Maximizing estate tax savings by having the trust continue until the Rule forces termination is even worse. The result may be a bunch of incredibly wealthy, very young great great grandkids ill prepared to receive more wealth rained upon them. Wouldn't it be better to keep the money in the trust?

Maybe the downside of a never ending trust is the risk of creating trust dependent descendants forever, rather than just for 100 years followed by the world's biggest party and a generation long hangover.

Does a trust spoil work ethic and values? I don't think so. Values and work ethic are affected by how a person is raised and, perhaps, by inappropriate access to money. It's overly simplistic to conclude that your wealth will spoil future generations. Families who teach stewardship and values do quite well with substantial wealth, whether or not it is tied up in long term trusts. The reasons should be pretty obvious.

Certainly, one should be concerned about interfering with ones---children's ability to raise their own children and your grandchildren's ability to raise their children. The question should be, "Is it possible to structure a trust with flexibility to meet changing circumstances and controls which allow parents to minimize the trust's interference with the values they wish to pass on to their children?"

Flexibility Concerns

No provision buried in a trust agreement will teach responsible stewardship. But there are many ways to build flexibility into a long term trust even though the tax law prohibits amending the agreement. For example, you can give the trustee:

  • broad discretion over investment decisions and other trust affairs;
  • the power to change the trust=s situs (governing state law) if necessary due to federal or local law changes or other circumstances;
  • limited or full discretion over distributions to beneficiaries. More importantly, you can give parents substantial discretion over their children=s financial affairs. For example, adult beneficiaries could have the power:
  • to cause the trust to distribute in whole or in part to charity;
  • to determine (with limited exceptions) the timing and amount of distributions to their children;
  • to completely change by will trust provisions governing future distributions to their children (or even to terminate the trust);
  • to alter by will their descendants' future sharing of the trust, even to the extent of disinheriting one or more of their children as they deem appropriate based upon the circumstances at the time.

Appropriate Governance

Who controls the trustee? Should a trustee have absolute control over the trust, or should be accountable to the beneficiaries? Give the beneficiaries too much control and you run smack into fears of kids running amuck. What checks and balances may be created? These questions are of great importance for long term trusts, since trustees will change over time.

You can give the beneficiaries the power to remove the trustee and hire another. If you are concerned that the beneficiaries will "shop around" for someone who will follow their bidding, you can restrict them to firing "for cause" or you can define acceptable replacements (i.e., a large bank).

You can give the beneficiaries substantial involvement in trust investment decisions, but restrict their personal access to the trust's cash flow. You can create committees of family members to make recommendations concerning trust distribution and investment philosophies.

In many ways, a trustee is to a trust as a CEO is to a business. We frequently recommend a board of outside directors as the way to ensure that the business is run in the best interests of all shareholders. You could create the equivalent oversight function for a trust.

An emerging concept in the U.S. is the notion of a "trust protector." This person can play an oversight role equivalent to a corporate board of directors. The trust protector can be elected by the beneficiaries or appointed from (or by) a predetermined list of people. The protector's powers can include replacing the trustee; approving major trust transactions; and the like.

The estate tax savings potential of long term, dynastic trusts is compelling. With careful thought, you can build in substantial flexibility to let your descendants deal with the uncertainties of the future. When combined with efforts to develop and perpetuate a family culture of stewardship and moral values, dynastic trusts can help perpetuate your business for future generations.

 

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