Who would you like to enjoy your wealth?.. You, your spouse and your “family” or the IRS? Here family means not only your kids and grandkids (born or yet to be born), but also future generations (many decades or even a century into the future).
Well, there is a secret strategy that allows you to legally disinherit the IRS and have your wealth pass estate tax free from generation to generation.
Say “Hello” to Dynasty Trusts… Secret because few—very few—lawyers know how to write and implement them.
What is a Dynasty Trust (DT)?
You create an irrevocable trust for the benefit of one or more beneficiaries, typically your children and/or grandchildren and their future descendants. The trust provides:
- For the support, medical care and best interest of the beneficiaries
- As an asset protection device
- Creditors of a beneficiary (i.e. get into an accident or financial trouble) from reaching trust assets
- To protect trust assets from a divorced beneficiary’s spouse
NOTE: Generally, beneficiaries cannot personally get at trust assets, but You can allow beneficiaries to distribute some assets to younger beneficiaries or even all of the assets (thus terminating the DT).
Now, the tax magic… Typically a DT lasts forever. So, your wealth passes from your kids (after receiving various benefits during their lives) to your grandkids and so on to future generations. Hard to believe, but each of these transfers (to future generations) is estate tax free.
Why?… Well, let’s look at the crazy American tax law that gives this tax-free reward. When you transfer assets (valued at fair market value on the day transferred) into the DT, that transfer is subject to gift tax. But wait, under current law, the tax-free gift tax amount is $5.34 million ($10.68 million if married). For example, you (assume you are married) transfer $10.5 million in assets to Your DT. Yes, taxable. But no, not one cent in cash is due to the IRS.
Say 25 years later your son (Sam) goes to heaven and his share of the DT is transferred to his kids (Your grandkids). No estate tax… because Sam did not own the assets. The trust owned those assets before Sam died, and the trust still owns them. Technically, there was no title transfer of assets. Result: no gift tax, no estate tax.
The assets in the DT compound tax-free for generations. The best way to see the dramatic dollar difference between a DT and an outright gift to Your heirs is by an example.
An article by Marty McKeever in Estate Planning in January, 2000 is the best example I have ever seen. The example is updated to 40% (the current highest estate tax bracket).
Here are the assumptions: $1 million is gifted (by Joe) to a DT. The trust benefits Joe’s child, grandchild and great grandchild for their lives and will pass outright to his great great-grandchild. The trust, after making distributions (specific amounts not given) to the various beneficiaries grows by a net of 6% annually. Each generation lives for 25 years longer than the prior generation.
|Value at child’s death||4,549,383||4,549,383|
|Less: 40% estate tax||-0-||(1,819,753)|
|Value at grandchild’s death||$19,525,245||11,715,571|
|Less 40% estate tax||-0-||4,686,228|
|Value at great-grandchild’s death||$83,800,336||$30,169,940|
|Less: 40% estate tax||-0-||12,067,976|
|Great great-grandchild receives||$83,800,336||$18,101,964|
Wow!… Tax-free compounds wealth. And that’s only $1 million to fund the DT. Most clients gift more. Play with the numbers.
What’s the income tax story?
In general, irrevocable trusts (like a DT) pay tax (federal and state) on their income. Any type of asset can be gifted to a DT, but selected assets—like municipal bonds, low-dividend or no-dividend growth stocks and non-income or low income assets likely to appreciate—are your best choice.
Also, a DT can be structured as a “grantor trust,” making the trust itself a tax-free entity. Instead, the creator of the trust pays tax on the income. More good news: those payments are gift tax free to the beneficiaries and the trust. Once the creator goes to heaven, the DT becomes subject to income tax.
Where is DT created? For how long?
For how long: Years ago all 50 states prevented DTs—because of the so-called “rule against perpetuities” (Rule)—from having a life beyond about 90 years. When the time was up, all assets had to be distributed to the then beneficiaries and the trust terminated.
That’s still the story in most states because the Rule remains law. But today, 23 states (plus the District of Columbia) allow DTs.
If you don’t live in a state that allows DTs, no problem. Simply, have your professional select the best State in which to create the trust. It’s hassle free. Then you can determine how long the trust should last: three generations, five, forever.
Where: If your DT will have significant income, have your professional pick a state that allows DTs, but does not have a State income tax.
More you should know
- Because of the long life of the typical DT, the trustee is usually a bank or trust company. The trust should allow for removal of the trustee to prevent being captive to high fees or poor performance.
- Consider supplementing, the income of an existing or yet unborn heir who engages in socially beneficial work or a low-paying profession (like teaching or police work).
- To prevent the beneficiaries from becoming dependent on the trust for support, consider drawing the trust to provide incentives: graduate from college, accomplish specific goals and/or other objectives that represent your personal values.
- Provide for gifts to charity… could be Your family foundation).
- Room prevents listing all the possibilities, but if You are worth more than about $15 million (or want to transfer Your business to Your kids, even if You or Your business is worth much less) talk to your professional about a DT. But be warned: all may be lost unless You work with professionals who know the ins and outs of DTs.
Call me (Irv) at 847-674-5295 if you think a DT might be right for You… or email me (firstname.lastname@example.org).
Free special report:
How to transfer your business (to your kids), yet keep control
When closely help with business owners call me for help with their business successions plan they typically have two goals:
- Get their business out their estate (particularly when it is growing in value) in a tax effective manner
- keep control for long as they live
it is a rare that the business owner finds an advisor who knows how to accomplish both goals.
this special report shows you how to keep absolute control of your business while transferring it to your successors.
Free Special Report:
How to legally eliminate your state tax liability
When people of means contact me to help do their estate plans (or review their existing plans), they typically have two goals concerning their estate tax:
- Reduce their potential estate tax liability
- Make sure there is enough liquidity to pay the potential estate tax liability
Well, my goal and the goal of this special report is to show you how to eliminate your potential estate tax liability whether you are young or old , married or single, insurable or uninsurable.
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