For the past several days I’ve been covering Generation-Skipping Transfer Trusts, which are also known by the name ‘Dynasty Trusts.’  Today’s posting will address how you may take advantage of this technique in your financial planning.

When clients or potential clients first meet with us one of the things they most often ask is how have a lasting impact beyond just their lifetime or even the lifetimes of their children.  If a client speaks with me about their desire to leave a legacy, and if the client has a substantial net worth, I often recommend a Dynasty Trust.

A Dynasty Trust is not so much a Trust as it is a technique that is designed to allow the originator of the trust to pass along their wealth from generation to generation to generation without the added burden of transfer taxes, including estate and gift tax and the generation skipping transfer tax.  The Dynasty Trust allows the Trust’s creator to deliver wealth to future generations of heirs…but the rules regarding distribution and usage of the trust are entirely set forth in the terms fashioned by the trust’s founder.  A Dynasty Trust is not to be entered into lightly and without considerable thought, as the trust is irrevocable and once it is funded even the founder no longer has control of the assets and will not be able to retrieve the assets or amend the terms of that trust.  Think long and hard before entering into this type of trust.  For many, it doesn’t take much thought; they’re clear establishing a Dynasty Trust—and their own familial dynasty—is the only way to go.

It’s important to note that although the Trust’s founder no longer retains control of the assets placed in Trust, the founder may still choose to nominate him or herself as a role-player of some form regarding the Dynasty Trust.  Were the Trust founder to establish their Dynasty Trust for use during their own lifetime—not simply for future use by descendents—then from the perspective of the IRS, the founder would be treated as the Trust’s owner during that time period.  While the Trust’s founder (also known as grantor) is alive, the grantor would be responsible for bearing the income tax burden.  Again, during this period while the founder/grantor is still living, the Trust would be regarded as a Grantor Trust rather than a Dynasty Trust.  The Dynasty Trust would be set up to kick in at the time of the grantor’s death.

So how might this apply to you?  Well, if you chose to create/found/grant a Trust and if you were choose to create a Dynasty Trust for your daughter, you would be able to decide what, if any, rights she’d have to decide who gets to inherit the Trust upon your death.  Perhaps you’d choose to bring your daughter’s husband in for a share of the Trust…perhaps you’d select to do otherwise.  If, for example, your daughter is young or irresponsible you might even choose to create a Dynasty Trust with specific rules and guidelines for what money would go to your daughter when, and under what circumstances.  You might even appoint a third party as a trustee to ensure your daughter holds to your pre-established terms.  By enforcing your rules and guidelines, the appointed trustee would ensure that, along with your Dynasty Trust, your money would continue to provide for your heirs for generations to come.

For the past several days I’ve been covering Generation-Skipping Transfer Trusts, which are also known by the name ‘Dynasty Trusts.’  Today’s posting will cover the real reason the Dynasty Trusts got their name in the first place!

While this may be a “Who is buried in Grant’s tomb?” question, why do you think that Dynasty Trusts are called Dynasty Trusts, anyway?  That’s right, because a Dynasty Trust creates a dynasty (or at least increase your odds of doing so!)

Now in order to think about your money from the perspective of future generations, versus thinking about your money from the perspective of what you might like to buy, donate or even splurge upon takes a shift in point of view.  That much is certain.  And holding the point of view that your money and all you’ve spent a lifetime building is for the future—rather than just for the here and now—is not everyone’s cup of tea.  So first you’ll need to contend with whether or not you’re the type of person who is interested in looking that far ahead and ensuring for future generations—generations that you may likely never even meet.

In setting up a Dynasty Trust not only will you have to contend with your own ways of thinking, but also with public opinion to a certain extent.  Why?  Well, for various reasons, bequeathing a large amount of money to multiple generations of your family has long been a controversial topic.  Even Warren Buffett, about whom we’ve written many times, has said that leaving generations of trust fund babies is “the enemy of a meritocracy.”

If you get beyond all of that and you do decide that the Dynasty Trust is for you, then please read ahead!

Why?  Because now may be the best time ever to create a Dynasty Trust, thanks to recent changes in our tax laws.  Under the new tax laws, the amount of your inheritance that is exempt from Generation Skipping Transfer Tax may be held within the Dynasty Trust for generation after generation with no additional estate tax due on your death, or the deaths of your descendents.  Don’t get me wrong; different states have different laws and regulations on these kinds of trusts, but in the world of trusts, these Dynasty Trusts are as close to “forever” as you can get.  And, you yourself can be vigilant about saving and invest your wealth instead of spending it—and if you can instill that same willingness to do so in your heirs—then your wealth (in terms of your Dynasty Trust) really can last forever; it will be able to grow for generations while avoid federal estate tax at each generation.

Is a Dynasty Trust right for you?  Only a qualified estate-planning attorney can help you decide.

For the past few days we’ve been posting a series about Generation-Skipping Transfer Trusts, which are also known by the name ‘Dynasty Trusts.’

Today’s posting begins with the most important thing to know regarding estate planning: estate planning is really not a do-it-yourself proposition.  Although there are many free wills and other legal documents you can download online—as well as will and trust software that’s available for purchase—but I liken those to performing oral surgery upon yourself.  Sure, you could do it, but chances are the money you’d save would be quickly eaten up by the ramifications of having done it incorrectly in the first place.  There are simply too many ins-and-outs; there are too many state-specific laws; there are too many ways to make a mistake, and estate planning is too important to leave to chance.  Why, because estate planning is about the decisions you’re making for not only yourself but also the people you love most.  Ensure you’re all taken care of in a rock-solid way.

Now, on to Dynasty Trusts.  How do you protect what you’ve spent a lifetime building?  One way to do that is with a Dynasty Trust.  We always recommend that a person choose a Trust over a Will, but this particular type of Trust provides something unique. First, since it’s in a Trust, your inheritance isn’t technically your property, even if you are the trustee.  Why I point that out is because that means your inheritance will benefit from creditor protection.  There are obviously no guarantees that you would never lose your inheritance in a lawsuit, however, your first line of defense is a properly drafted and managed Dynasty Trust.  Ideally, that should provide the protection you need if you ever get sued.

One question that people often come to me with is how to protect everything they’ve spent a lifetime building in the case of divorce—be it their own divorce or the divorce of one of their heirs.  One of the good reasons for a Dynasty Trust is because since your inheritance is held in a completely separate trust—which means that it’s held separately from your other assets—it’s easier to protect the status of that trust a separate and distinct property than if you held everything directly in your name.  Since, legally speaking, you don’t own your Dynasty Trust, neither will your spouse in the case of divorce.  The same situation will apply for your heirs and their spouses.

Yesterday we started a series of posts about Generation-Skipping Transfer Trusts, which are also known by the name ‘Dynasty Trusts.’  So where to begin today as we explore what these trusts are and what they might provide for you?  I’ll begin where many of my clients and potential clients begin when starting the estate-planning process; they often times start with a handful of understandable questions:

How do I avoid losing all I’ve earned on taxes?

What happens with the inheritance I want to pass on to my heirs?

Is it possible to create an non-contestable estate plan?

How do I pass on more than just my money; how do I pass on strict instructions on the use of that money?

In what way could I ensure that the money I leave to my children or grandchildren doesn’t end up in the hands of one of their spouses—or worse yet, their ex-spouses—instead of in the hands of my direct descendants?

These questions are reasonable and logical; all of your questions regarding the protection of your life’s worth are reasonable and logical.

A possible solution for your estate planning needs may be the execution of a Dynasty Trust; these generation-skipping transfer trusts are intended to protect the inheritance you leave to your heirs.  These trusts are designed to protect your legacy from creditors, from future estate taxes and from future in-laws and spouses, and future estate taxes.

Your next question might be, “So what does a Dynasty Trust look like in action?”  Well, as an example, you could update your estate plan to leave your children an inheritance in a Dynasty Trust instead of simply bequeathing the inheritance to them.

Why would you want to enact a Dynasty Trust?  Because of the advantages that this type of trust carries. What are those advantages?

If you have a big vision for your life, your future and your legacy, you want to set up your estate plan in such a way that all you’ve spent your life building can never be taken from you or your heirs through divorce, lawsuits or estate tax.  You certainly don’t want all you’ve spent your life building to be piddled away by some ex-son-in-law’s purchase of a Range Rover, or have your family watch their inheritance slip through their fingers and become the property of the IRS.  There are ways to protect what you spend your life building and, just like anything else it’s best to act now, rather than waiting until it’s too late.  As the saying goes: It’s far better to be proactive than reactive.

What’s all the fuss about Dynasty Trusts?  That’s what this series of blogs is about to uncover.  Many clients and potential clients raise a similar question; they want to know about the so-called “Dynasty Trusts” they’ve been hearing so much about.  Rather than leaving you to your own devices, I thought I’d cover them in depth over the next few postings.

A Dynasty Trust, also known as a Generation-Skipping Transfer Trust provides several things for the trust’s creator; namely it provides longevity that other Trusts may not, and secondly it provides estate tax savings that can be substantial.

Regarding the longevity factor, Dynasty Trusts can be set up in certain states that have modified what is known as the Rule Against Perpetuities, an olde English, common law, concept that specifies a trust cannot last for longer than 21 years plus ‘lives in being.’  One of the factors that most grantors who found a Dynasty Trust like most about it is the fact that it can go on ‘forever,’ depending on the specific laws of the state in with it was founded.

Regarding the factor of substantial estate tax savings, read on.  Thanks to a recent change in tax law, this formerly-controversial approach to providing for one’s family over the long-term has become quite popular.

You may be familiar with the Tax Relief Act, which recently passed in December of 2010.  This long-awaited act created the option to fund trusts of $5 million and over without incurring as big a tax bill as in the past. What 2010’s Tax Relief Act has done in the process is promote the formation of generation-skipping transfer trusts.

So why should you care?  Well, for starters, it’s estimated that taking into account the estate taxes that are applied to each generation, one could save 80 percent of one’s estate through three generations by simply executing a Dynasty Trust.  Intrigued?  You may well be.  Over the next few days we’ll cover some of the ins and outs of the trusts, as well as some commonly-asked questions.  Stay tuned.  You’ll be glad you did.

A Crummey Trust may be used to describe what is more correctly called an Irrevocable Life Insurance Trust.  The trusts—which are named after D. Clifford Crummey, a Methodist minister who took on the IRS and won back in the 60’s—are Life-Insurance Trusts with provisions that allow gifts to the trust to qualify for the annual gift tax exclusion.

Crummey Trusts are most often established to protect life insurance from federal estate taxes, although they may contain a variety of other assets as well, such as real estate, stocks, and bonds.

While Crummey Trusts are used in many different types of circumstances, they’re best fitted for making gifts to minors.  When a Crummey Trust is executed for the benefit of a minor, the Trusts qualify the minor for exclusion from the unified gift and estate tax.  Furthermore, the Trust serves to protect both the minor and the assets when substantial assets are bequeathed upon minors who aren’t yet prepared and able to deal responsibly with assets.

Due to the fact that Congress raised the lifetime threshold for tax-free giving to $5 million in 2011 and 2012, the Crummey Trust can make good sense for a lot of people who want to gift assets to hers and avoid gift tax in the process.  To execute a Crummey Trust, one first purchases a life insurance policy—which is why I initially wrote that a Crummey Trust may be used to describe what is more correctly called an Irrevocable Life Insurance Trust—then fund the premiums with annual gifts.  Currently, the annual cap on gifts to individuals is #13,000.  Because the life insurance policy is owned by the Trust, the death benefit ultimately goes to the trust, shielding it from federal estate taxes.

Typically and for good reason, gifts to minors are subject to parental or guardian control until the minor has matured to the age of eighteen.

A Crummey Trust provides the beneficiary a window of time, usually thirty days, to take immediate control of the gift.  If the beneficiary does not take control of the gift during that window, the gift becomes part of the trust, and is subject to the trust’s distribution conditions.  Where the uniqueness of this Trust comes into play is that because the beneficiary had the opportunity to receive the funds outside of the trust, the gift falls into the annual exclusion.

To enact this unique feature of the Crummey Trust, the trustee is mandated to issue annual written memoranda to the beneficiaries, informing those beneficiaries that they may withdraw that gifted amount within the set time frame.  To comply with IRS regulations and to have the gifted amount pass along tax-free, the beneficiary must take ownership of the gift in the allotted time frame, using the written memoranda as proof.  The annual written memoranda to beneficiaries is known as a Crummey letter. 

As with any Trust, please enlist the help of a qualified estate-planning attorney before you attempt to execute one.

A Credit Shelter Trust is a type of trust that married couples would use to pass assets along to their heirs and avoid estate taxes while doing so.  A Credit Shelter Trust is also known as an A/B Trust.  The contingency is that a Credit Shelter Trust only works if you are married at the time of your death.  The purpose of a Credit Shelter Trust is to save money that you’d pay in estate taxes—also known as death taxes—that the IRS collects when someone dies.

Here’s the backstory: the federal government allows every person to give away a certain amount of money without being taxed on those gifts.  The current amount that the government allows any one person to give is $5,000,000 and a person may choose to give that money throughout their lifetime as they see fit, or they may bequeath it upon their death.

Where this gets interesting is when you add in this factor: the IRS allows a married person to either give away to their spouse or to leave their spouse when they die an unlimited amount of assets—you read that right—an unlimited amount of assets.  This perfectly legal loophole is known as the Unlimited Marital Deduction.

Usually when a couple is married—if they’ve done any estate-planning at all—they set up wills which give the whole of their property to the surviving spouse at time of death.  The problem with this?  Well, it throws away the Unlimited Marital Deduction for one.  This is where a Credit Shelter Trust kicks in; it basically shields the $10,000,000 from high taxation, by allowing each spouse to “gift” that amount to the surviving spouse.

Of course none of us knows when we’ll die; even if a person is critically ill, all they can do is guess, so the next part of what I’ll write is a hypothetical speculation.  For the years 2011 and 2012 the federal estate tax exemption has been made transferable between spouses.  This transferable estate tax exemption is aptly named the “portability of the estate tax exemption.”  What does that mean to you?  Well, if you’re a married couple and one of you should pass away in the 2011 or 2012 calendar years, then that person’s and his or her entire estate tax exemption is not needed to avoid estate taxes on his or her estate, then the unused portion of the deceased spouse’s estate tax exemption can be added to the surviving spouse’s estate tax exemption.  Again, why should this matter to you?  Well, if you’re a married couple and if one of you should pass away in 2011 or 2012, you’ll be able to pass on more of your money to your ultimate beneficiaries than you would if you did not use a Credit Shelter Trust.

Credit Shelter Trusts are relatively easy to set up—if you’re an estate-planning attorney and you know the law—this is not something you want to attempt on your own.  The qualified estate-planning attorney simply includes the Credit Shelter Trust in the couples Will or Trust.

To understand a Constructive Trust, we must first understand that a constructive trust is not a trust, in the typical sense.  Typically a trust is an estate-planning tool into which the grantor has titled their assets, and an appointed trustee has duties of administration enduring for a substantial period of time.  A Constructive Trust is not that; it is generally the result of litigation over misused assets or assets that have been absconded with. In a constructive trust the defendant breaches a duty owed to the plaintiff. The most common such breach is a breach of fiduciary duty.  A Constructive Trust is a passive, temporary arrangement, in which the trustee’s sole duty is to transfer the title and possession to the beneficiary.

A Constructive Trust is a temporary, equitable remedy that is imposed by a court to benefit a party that has been wrongfully deprived of its rights due to either a person obtaining or holding legal right to property that they should not possess.

How did the person “obtaining or holding legal right to property that they should not possess” come to possess the property in the first place?  There are a number of ways.  Some of the ways a person can obtain or hold legal right to property that they should not possess include property obtained by:

• Breach of trust
• Breach of duty (by executor) in dealing directly with the beneficiary
• Coercion
• Concealment
• Duress
• Fraud
• Fraudulent misrepresentation
• Gift (by Will, Trust, or Intestacy, based upon misrepresentation, fraud, concealment, a broken promise, disloyalty, or breach of trust)
• Homicide
• Ignorance
• Inadvertence
• Mistake
• Theft
• Undue influence

The plaintiff (or “aggrieved party”) typically is afforded a choice between a Constructive Trust or another legal remedy, oftentimes simply the recovery of the assets which were absconded with.  The plaintiff is able to select one legal remedy or the other; they are not entitled both types of relief.  When a Constructive Trust is assigned, it is done so as one form of legal remedy.

From a legal standpoint, a Constructive Trust, must rule over specifically-named property; it can’t be hypothetical in nature, based upon speculative “property,” but, rather the specific property must be named.  A Constructive Trust does not apply in cases of breach of contract where no actual ownership of property is involved.  Due to the very unique constructs and applications of a Constructive Trust, many debate whether a Constructive Trust is, in fact, a trust at all.

In addressing Split-Interest Trusts we’ve seen that they are unique types of trusts that are established to benefit both charitable and non-charitable recipients.  These trusts are designed for those who have both philanthropic and family needs to attend to.

The final type of Split-Interest Charitable Trust we’re covering is the Charitable Remainder Unitrust with Net Income Make-up Provisions (“NIMCRUT.”)

To quickly recap Charitable Remainder Trusts: in the simplest of terms, they are irrevocable trusts that are created to reduce taxes.  First they provides funds for named beneficiaries for a specific period of time, then, after that specific period of time, the remainder of the trust is given to a pre-designated charity.  Until the trust’s assets are donated to charity, the grantor has the benefit of being able to use the assets as they see fit.

Charitable Remainder Unitrusts with Net Income Make-up Provisions (“NIMCRUTs”) are a type of trust that allows you to provide income to yourself or others for life, or a fixed term, and to receive a tax deduction while doing so.

The important difference with NIMCRUTs as opposed to other Charitable Remainder Trusts, is that NIMCRUTs don’t allow the usage of the trust’s principal for the payout of income. If there is insufficient income to meet the payout, the income beneficiary must wait until sufficient income exists. Until such time however, the income beneficiary’s “make-up account” will continue to build. Once income is sufficient, the income beneficiary will be entitled to the entire buildup in the “make-up account.”

The trust pays out only actual income it has earned.  If this payout of interest and dividends is less than the specified percentage as stated in the trust documents, the shortage is accumulated and paid to the beneficiary at some future date, which is where the name of the trust comes into play.  The Net Income Make-up Provisions kick in whenever this happens. The “make-up provisions” allows the trust to “make-up” any deficiencies (under the pre-set, fixed pay-out percentage) during any year in which the net income of the trust exceeds the fixed pay-out percentage.

For example, assume that the trust earns 6% in interest and 16% in unrealized capital gains during the current year. The beneficiary receives only the 6% earned interest with the 16% in unrealized capital gains being accumulated for distribution to the beneficiary at a future date when the recognized income in the trust is sufficient to affect the payout. In those situations where the trust has no income from interest and dividends, the shortage owed to the beneficiary is accumulated for future distribution to that beneficiary.

Do yourself a favor; if you think a NIMCRUT is right for you, consult a qualified estate-planning attorney.

We’ve been addressing Split-Interest Trusts recently; those are unique types of trusts that are established to benefit both charitable and non-charitable recipients.  These types of trusts would be a match for you if you have both philanthropic and family needs to attend to; if you both want and need to care for your family, but you also want to take advantage of the tax breaks you’d receive from setting up some form of Charitable Trust.

The final type of Split-Interest Charitable Trusts we’ll cover today; it’s known as the Charitable Remainder Unitrust with Net Income Make-up Provisions (“NIMCRUT.”)  NIMCRUT is one heck of a name, isn’t it?  Well, it can also provide for one heck of a trust, too.  I’ll explain.

To understand any of this trusts, you must first understand the Charitable Remainder Trust, which I’ll quickly recap:

In the simplest of terms, a Charitable Remainder Trust.is nothing more than a irrevocable trust that is created to reduce taxes.  First it provides funds for named beneficiaries for a specific period of time, then, after that specific period of time, the remainder of the trust is given to a pre-designated charity.

The assets of a Charitable Remainder Trust are ultimately donated to charity, but until that time, the trusts’ grantor has the benefit of being able to use the assets as they see fit.

Charitable Remainder Trusts give money to non-charitable beneficiaries first—meaning the non-charitable beneficiaries reap the lead interest.  Once the lead interest period is complete, the remainder of the assets in the trust are given to the pre-determined charity or charities of the grantor’s choosing.

The benefit of this type of trust is twofold: the grantor both avoids the burden of capital gains tax on the gifted assets, as well as enjoying an income tax deduction for the fair market value of the remainder interest that the trust earned in the meantime.

Charitable Remainder Unitrusts with Net Income Make-up Provisions (“NIMCRUTs”) are a type of trust that allows you to provide income to yourself or others for life, or a fixed term, and to receive a tax deduction while doing so.

A NIMCRUT pays interest income for life (or, again for a fixed term) to a non-charitable lead-interest beneficiary. The remainder of the interest is ultimately given to a charity.

The NIMCRUT doles out a specified percentage of its value annually.  The non-charitable lead-interest beneficiary receives only the interest and dividends earned by the trust for the current year.

NIMCRUTs are not the kind of thing you want to dabble with on your own; if you believe one might be a fit for you, please see a qualified estate-planning attorney.