Generation-Skipping Transfer Trusts & Dynasty Trusts
Like the federal gift and estate tax exemption, each taxpayer has an exemption from the Generation-Skipping Transfer Trust (GSTT) equal to $11,180,000 for estates of decedents dying in 2018 (annually indexed for inflation). Unlike the federal estate and gift tax exemption, the GSTT exemption is not “portable” between spouses. If a spouse does not fully utilize his or her GSTT exemption during lifetime or at death, the balance is not available to the surviving spouse for later transfers. With proper planning, the first $11,180,000 (or $22,360,000 if properly allocated and utilized by a married couple) can move from one generation to the next, for a very long period of time, without the imposition of a death tax at each subsequent generation.
Once the careful use of these exemptions is completed, a tremendous opportunity for estates to shelter significant assets from inter-generational transfer taxes exists. Even when the inheritance is relatively small, the ability to protect the assets from taxes, creditors and predators through multiple generations can be valuable. Remember, the GSTT equivalent amount must be used because it cannot pass to the surviving spouse’s estate if unallocated.
The proper use of generation-skipping transfer trusts may even allow the heir or heirs to be the trustee of their own trust. Usually, trustee discretion is employed so that the trustee is not deemed to “own” the property in the trust for inclusion in their own estate. The right to use all of the income earned in their trust, the right to spend principal for health care, education, maintenance and support, as they determine appropriate, in their own discretion, can be provided. In addition, the right to disburse funds to others in any amount during their lifetime (through an “inter vivos power of appointment”) and the right to disburse funds to others in any amount through a “testamentary power of appointment” at their death either via Will or trust can be stipulated.
What is a "Dynasty Trust," & How can Life Insurance help?
A Dynasty Trust is a type of generation-skipping trust that is designed to last for generations with some never terminating. Whole life insurance owned by the trust can help because it pays a death benefit at the death of the insured to the trust as the beneficiary of the policy.
There are a number of states, including Alaska, Arizona, Colorado, Delaware, District of Columbia, Florida, Hawaii, Idaho, Illinois, Kentucky, Maine, Maryland, Michigan, Mississippi, Nebraska, Nevada, New Hampshire, New Jersey, North Carolina, Ohio, Pennsylvania, Rhode Island, South Dakota, Tennessee, Utah, Virginia, Washington, Wisconsin, and Wyoming that allow some version of a perpetual or a Dynasty Trust. Let’s take a look at the way life insurance can help utilize a hypothetical second-to-die policy on the lives of the couple described.
Some of the numbers shown may be affected by inflation adjustment changes due to the Tax Cuts and Jobs Act enacted on December 22, 2017. Please refer to www.IRS.gov for the most up-to-date information.
Todd and Carol, a very successful married couple in their 70s, are part owners of a privately held family business. Their combined net worth is estimated to be over $20 million, with most of it in investments and a minority interest in the business. They have three children: Kate, Al and Rich. All of their children are married and successful in their own right, and all are in their mid-40s to late 50s. Each has three children, so Todd and Carol have nine grandchildren who range between 13 and 25 years old. The eldest son, Rich, purchased the majority share of the business from his father and is the CEO of the business. A few of their grandchildren are considering working for the family business, while others are striking off on their own to start their own businesses.
If Todd and Carol were to die under the current estate tax regime with an estate of $50,360,000, their estate tax exemptions would shelter $22,360,000 for their children, and their combined estates would be depleted by $11,200,000 for estate taxes. Collectively, their children would receive $16,800,000.
If we stay at the children’s generation only, Kate, Al and Rich would inherit $5,600,000 apiece. Assume each child is currently worth $10,000,000 plus the inheritance, and each child lives another 25 years. With just the inheritance and their current net worth, each child has an estate that would be subject to significant estate tax with no growth.
Now, let’s assume the assets grow during that time frame at the current inflation rate of 2% per year. In 25 years when Al, Kate and Rich, and their spouses die, the full value of Todd and Carol’s estate would have been consumed by federal estate taxes, which were paid by their estates. To summarize, Todd and Carol paid $11,200,000 in federal estate tax and, assuming an estimated exemption equivalent amount 25 years from now and after the children’s estates have grown to approximately $35,000,000, each child and spouse would have the year 2043’s inflation adjusted exclusion amount available. For purposes of this publication, the 2018 amount of $11,180,000 (indexed) sunsets as of December 31, 2025, and reverts back to $5,000,000 (2010 amount) adjusted for inflation. In the year 2043, we estimate the amount to be $9,174,000 per person ($18,348,000 per married couple). Assuming $35,000,000 estates less $18,348,000, $6,660,800 would be lost to estate taxes, per couple/family. This brings the total tax bill to $17,860,800. If a dynasty trust had been utilized, this amount would have been saved.
Had Todd and Carol used a Dynasty Trust during their lives, that trust could have purchased life insurance on both of them with the overall result being substantially different. Let’s say that the Dynasty Trust was set up during their lives using some or all of their combined $18,348,000 lifetime exemption amount. A $3,000,000 survivorship life insurance policy was owned and purchased by the trust and it paid at the eventual death of Todd and Carol. If the Dynasty Trust (including the death proceeds) was invested at 2% for 25 years, it could be worth $22.4 million, which would then be spread across multiple generations. While the “initial amounts” in the Dynasty Trust are still included in the estates of Todd and Carol, the growth of the assets and the life insurance death proceeds are not included in the estates of Al, Kate and Rich. In short, greater than $20 million of initial assets and growth can be protected from future estate taxes by using a properly structured Dynasty Trust.
For a wealthy family, keeping money in the family for multiple generations can be accomplished by understanding the GSTT and working with your Lenox Advisor and estate planning team.
The information provided is not written or intended as specific tax or legal advice and may not be relied on for purposes of avoiding any federal tax penalties. Lenox Advisors, Inc., its employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Lenox Advisors, Inc. (Lenox) is a wholly owned subsidiary of NFP Corp. (NFP), a financial services holding company, New York, NY. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 90 Park Ave, 17th Floor, New York, NY 10016, 212.536.6000. CRN202206-266433