To Trust or not to trust?

To Trust or not to trust?

Why I Recommend a Family Dynasty Trust for Estate Planning

In the complex world of estate planning, the decision of how to leave one’s legacy involves a multitude of considerations. After years of guiding clients through this intricate process, I find myself consistently discussing the merits of a family dynasty trust. This approach to estate planning aims to safeguard family wealth within a trust structure for many generations. In this article, I’ll delve into the options available, share my perspective, and weigh the pros and cons of this approach.

Options for Estate Distribution

Navigating estate planning can be a complex, emotional, and highly personalized process. I read dozens of estate plans every year, and each one has unique characteristics. That said, there are three common options that I see time and time again, worth discussing.

One of the most common forms of estate distribution is an outright distribution to heirs. Wills or trusts with this provision direct the executor to distribute all inheritance directly to the named beneficiary. Another common option for estate distribution is what I refer to as an “age-break trust.” Documents with this language will direct that assets be held in trust for a beneficiary until they reach a certain age, at which point, all or a portion of the trust will “break” and be distributed outright to the beneficiary. The final option is called a dynasty trust – with this language, all assets will be held in trust for the named beneficiary, in perpetuity, for the benefit of many generations.

Benefits to Family Dynasty Trusts

For families with wealth, a family dynasty trust should be considered. There are significant benefits offered by a dynasty trust that are lost when assets are distributed outright to a beneficiary. 

Tax Savings

One of the biggest reasons for establishing a trust is for tax planning purposes. When structured properly, dynasty trusts are exempt from federal estate taxes and state inheritance taxes. The federal estate tax is a 40% tax on any assets above the lifetime gift tax exemption. The lifetime gift tax exemption is currently $13.61M per person but is subject to decrease to ~$6M at the end of next year. For historical context, in the early 2000s, we saw this exemption as low as $1M and the tax rate as high as 50%! I point this out to illustrate that although the estate tax may not apply to you today, it could apply to you in the future pending legislative changes. In Pennsylvania, our state inheritance tax is 4.5% for all transfers to direct lineal descendants. Passing assets in a family dynasty trust can shield family wealth from this whopping tax forever. Depending on the size of your estate, utilizing a dynasty trust could save you, your children, your grandchildren, and your great-grandchildren millions of dollars of tax that would otherwise be paid if the estate were distributed outright to heirs.

Protection from Creditors 

Another huge benefit to a dynasty trust is creditor protection. Trust distributions are controlled by someone known as a trustee. A trustee is chosen and named in a trust document by the trust grantor, or individual funding the trust. When the trust is drafted, the grantor defines dispositive provisions. These provisions detail how, when, and why distributions should be made to a trust beneficiary. The trustee is empowered to make distributions for any requests that align with the dispositive provisions and deny distributions for requests that do not align with the dispositive provisions. If beneficiary funds are sought out by a creditor, the trustee can deny the release of funds, creating a robust defense against potential threats such as divorce, bankruptcy, or lawsuits.

Protection from Poor Decision Making

As illustrated above, trusts can provide strong protection from external forces seeking to seize inherited funds. But sometimes, a beneficiary may need protection from internal forces. As hard as it can be to accept, beneficiaries, especially young and inexperienced ones, don’t always make the best spending decisions. We also live in a world where fraud, gambling, substance abuse, and spending addictions are rampant. The trustee of a dynasty trust will only make distributions that align with the grantor’s intentions for the funds and are in the best interest of the trust beneficiary. This layer of protection is meant to prevent trust funds from being squandered so that they may continue for generations to come.

Drawbacks to Family Dynasty Trusts

While there are many benefits to dynasty trusts, no strategy is perfect for every situation, and this is no exception. There are several implications and drawbacks associated with dynasty trusts that families should be aware of when committing to this type of estate plan.

Hurt Feelings 

As an advisor, I see the time and emotional investment that families undergo to draft an estate plan that protects wealth and preserves it for many generations. Unfortunately, the beneficiary is often not privy to these conversations or the decision-making process. All too often, a beneficiary will learn of their family estate plan following the death of a family member. They are often surprised and hurt that their family left their inheritance in a trust – often wondering if this was done because the family doesn’t trust them to make good decisions.

In my opinion, a beneficiary should never find out about an estate plan after a death. I encourage the clients that I work with to have ongoing family meetings, often facilitated by me or another trusted advisor. These meetings are intended to educate and coach the beneficiary on trust mechanics and the family’s intention for the funds. These meetings create a safe space to ask questions, digest information, and create a shared family vision for the future.

Poor Trustee Relationships

The trustee/beneficiary relationship is one of utmost importance. As illustrated above, the trustee has a tremendous amount of power over the day-to-day operation of the trust and these relationships are often lifelong. I’ve witnessed situations where a trustee becomes power-hungry, causes unnecessary headaches or friction for the beneficiary, or simply doesn’t like the beneficiary. This is a bad situation and one that we want to avoid at all costs.

Trustees should be chosen carefully at the drafting of the trust. Oftentimes, families will choose a trusted friend or relative to serve in this role. Other times, they will look to a professional trust company to serve as trustee. Each choice comes with its own set of pros and cons. The most important thing that a grantor can do to mitigate this concern is give the beneficiary the ability to fire and replace their trustee. Depending on the circumstances, a family might also give the beneficiary the ability to serve as sole or co-trustee upon reaching a certain age to further empower the beneficiary and enhance flexibility.

Lack of Flexibility

Occasionally, I will see trust documents that have very obstructive dispositive provisions. I’ve also seen trusts that require the beneficiary to meet certain metrics or standards before they “earn” access to the trust (4-year college degree, six-figure income, a healthy relationship with other family members). This type of language often causes resentment or frustration for a beneficiary who is unable to access money that they feel entitled to.

Access provisions are a very personal decision, and every family has slightly different preferences on how, when, and why a beneficiary should be able to access funds. I’ve included some very common access provisions below:

  1. Distributions can be made for health, education, maintenance, and support (commonly referred to as HEMS).
  2. Distribution can be made for any reason or purpose.
  3. Distribution can be made for weddings, first-time home purchases, or to start or purchase a business.
  4. All income generated in the trust must be distributed to the beneficiary quarterly.
  5. The beneficiary is entitled to 5% of the trust value each year.

Some families will use all these provisions, and some will use none. There is no right or wrong answer, but I generally encourage my clients to maintain as much flexibility as possible within their trust documents.

Exceptions to the Rule

Financial advice, especially that pertaining to an estate plan, is very nuanced. While I appreciate the benefits of dynasty trusts, it’s impossible to give blanket advice that will apply to every client situation. There are many situations where a dynasty trust may not be the right choice for your family’s wealth. The size of the estate, the makeup of the assets, and the age and situation of the beneficiary will have a large influence on decision-making. Creating a trust can be expensive and the ongoing administrative burden associated with maintaining a trust may outweigh the benefits. If you have any questions about the appropriateness of a dynasty trust for your specific family situation, please reach out to us.[i]

In Conclusion

In the complex landscape of estate planning, the decision of whether “to trust or not to trust” is deeply personal. For families with substantial wealth, the advantages of a perpetual family dynasty trust, from tax benefits to asset protection, make it a compelling option. While it may not be suitable for everyone, careful consideration of the pros, cons, and exceptions can guide individuals toward making the best choice for the enduring legacy of their family wealth.

[i] The creation and drafting of trusts are complex legal processes that require careful consideration of numerous factors. It is highly recommended that individuals seeking to create or amend a trust seek the advice and assistance of a licensed attorney with experience in trust law. The information provided herein is for general informational purposes only and should not be construed as legal advice.

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About the Author

Samantha Spitzer Sheetz, CFP® specializes in financial analysis, estate planning, tax planning, and divorce planning. She enjoys building long-term relationships with clients through wealth planning.

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