What are Dynasty Trusts

Dear Len & Rosie,

I am helping my 85-year-old mother ensure that her estate plan is in order, and I am also planning for myself. I am very interested in the dynasty trust, but am confused about a few aspects. What are they all about?

Norman

Dear Norman,

One of the questions about estate planning is what happens to the inheritance you pass on to your children. Will they spend it? Will they lose it in a lawsuit? Will they give it to their spouse instead of leaving it to your grandchildren? Do you want your ex-son-in-law driving a Lexus bought with what used to be your money?

Dynasty trusts are designed to protect the inheritance you leave to your children from creditors, spouses, and future estate taxes. Your mother can update her estate plan to leave you an inheritance in a dynasty trust instead of giving it to you out right. There are several advantages to this.

First, since it’s in a trust, your inheritance isn’t really your property, even if you are the trustee. That means your inheritance will benefit from creditor protection. While we cannot guarantee that you would never lose your inheritance in a lawsuit, a properly drafted and managed dynasty trust should protect you if you ever get sued.

Second, since your inheritance is held in a completely separate trust, segregated from your other assets, it’s easier to protect its status as your separate property than if you held everything directly in your name. Since you don’t really own your dynasty trust, neither will your spouse, even if you get divorced.

Third, and perhaps most importantly, a dynasty trust creates a dynasty. 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 descendants. The duration of the dynasty trust is limited only by a law called the Uniform Statute Rule Against Perpetuities, which requires a final outright distribution of the trust within 90 years of your mother’s death. And it’s even possible to create a dynasty trust in certain states (not California) that may last forever. The point here is that if you invest your inheritance instead of spend it, then it can continue to grow for generations while continuing to avoid federal estate tax at each generation.

If your mother creates a dynasty trust for your inheritance, she will be able to decide what, if any, rights you have to decide who gets to inherit the trust upon your death. Maybe she’ll let you cut your wife in for a share. Or maybe not. She could even create a dynasty trust for your benefit with someone else as trustee if you’re not so good with money. With a dynasty trust, your mother can provide for her descendants for generations to come.


Len & Rosie

How Can I protect My Inheritance From Myself

Dear Len & Rosie,

My parents are fairly wealthy - they are worth over five million dollars. Is if there any way I can put a barrier between me and my inheritance? I tend to be irresponsible with money. I played the lottery a lot and I used to make high risk investments. Some investments have paid off but more have lost money. If I suddenly came into a million dollars, I don’t know what would happen. I don’t really trust myself. How do I tell my parents something like this without outright saying I am a bad person?

Dear Sam,

The first step towards solving any problem is recognizing you have a problem. You are certainly not a “bad” person because you lack prudent investment skills. There are several approaches you can take to preserve your inheritance once you get it.

Given that you’re a lousy investor, get help. Don’t listen to the little voice in your head that says to hold onto an investment that isn’t doing well. Making investment decisions based on hunches alone isn’t investing. It’s gambling. Instead, hire a financial advisor with a good track record and rely on that person’s advice. Consider having two separate financial advisors, so you can see how well they do against one another.

You should also talk to your parents. Instead of leaving you an inheritance outright, they could create a dynasty trust for your benefit. The idea behind a dynasty trust is that there are three fundamental problems with inheriting wealth. You can get sued and lose your inheritance. You can get divorced and see your spouse drive into the sunset in a Lexus your parents paid for. And, if you’re lucky (or have a skilled financial advisor) you could do very well with your investments, so well in fact that your children will have to pay federal estate tax on your death.

A dynasty trust is, at its heart, a “spendthrift” trust that is not subject to the claims of the beneficiary’s creditors (except for child support creditors and the IRS). It’s also a convenient means of protecting your separate property inheritance in the event of a divorce. And your inheritance, and all of its appreciation, will be exempt, for the most part, from federal estate tax on your death.

With a dynasty trust, your parents can create a framework to manage your inheritance. The trust could require you to hire a financial advisor. If you are extremely bad with money, they could go so far as to make someone else your trustee, perhaps a brother or sister. Or maybe you and another person can be co-trustees, and you could be restricted from spending over a certain amount without your co-trustee’s agreement. Your parents can also write restrictions in the trust as to how assets are to be invested. They can allow you to leave the trust upon your death to anyone you want, or they can require you to leave it to family members only.

It’s important to remember that proper estate planning isn’t done by filling in the blanks on a one-size fits all boilerplate document. It’s about analyzing an estate and developing a multi-generational estate plan that will help your parents and their children achieve your goals.

Len & Rosie