Estate Planning, Wills, Trusts and Probate Questions

Fundamental financial planning is generally insufficient for significant high-net-worth individuals who are interested in leaving their legacy after they pass away. When planning, these individuals often have accomplished a significant body of work in their lives, work that is accomplished and productive, they have established values and traditions or have inherited them, and with the success they have achieved, they generally wish to pass this along in the world before they either become incapacitated or pass away.

What Is Legacy Planning?

With a wide range of unique situations, the need for informed legacy planning is growing. Today’s clients require planning that reflects consideration of current laws, takes into account the clients’ situations and provides a framework for decision-making if they become incapacitated or pass away.

Parents who have considerable wealth are often faced with a dilemma when it comes to leaving bequests to their children. A major concern is that their children are not going to live as well as they did when they were under their parents care or as well as their parents would wish them to. Alternatively, parents are concerned that the wealth that is left to their children will only act to enable them and not empower them. The concern is that their act of love and generosity will only engender a lack of motivation and responsibility.

What Is The Incentive Trust?

An incentive trust is an irrevocable life insurance trust that can contain “incentive provisions” to encourage certain positive behaviors in beneficiaries that reflect the grantor’s values and motivate beneficiaries to be productive members of society.

Incentive trusts offer an excellent way to combat the diminution or complete lack of ambition and drive that a large inheritance can sometimes create. Typical incentive provisions would include requirements that the child or children who are the beneficiaries continue pursuing formal education, starting a family, purchasing a home, start a business, maintain a job (through salary matching or other incentive), or supplementing low wages earned in a public interest career. Incentive provisions are not limited to Irrevocable Life Insurance Trusts (ILITs) and can be included in many types of trusts, including dynasty trusts. If incentive provisions are desired, the advice of legal counsel is imperative, especially given that an omitted or displeased beneficiary could seek to contest the enforceability of a specific incentive provision.

What Are Dynasty Trusts?

A dynasty trust is often referred to as a “family bank” trust, a legacy trust, or a generation-skipping trust because it can be used to achieve many different goals.

A dynasty trust is often structured so that each successive generation of beneficiaries will receive income from trust property. Additionally, by giving the trustee discretion in making distributions, the trustee can exercise great flexibility and authority in meeting the needs of the specified beneficiaries. The trust often will not include provisions for mandatory distributions of principal, thereby ensuring the continuation of the trust through several generations.

A dynasty trust is usually created where the property or other asset is located in a jurisdiction that has either repealed the rule against perpetuities (RAP) or has extended it for a period of time beyond 100 years. For states that have retained the RAP, the duration of a trust is limited to the common law time period, which is usually “the time period encompassing the lives in being at the time of creation of the trust, plus 21 years.”

This blog’s intention is not to get into legal technicalities regarding the rule against perpetuities, so no further discussion will be made on the subject at this writing.

In the context of life insurance, if the insured had no incidents of ownership in the life insurance policy at any time within 3 years prior to his or her death, the policy proceeds will not be included in the insured’s taxable estate. To assure that the life insurance policy is excluded from the grantor’s estate, the original policy applicant should be a third party, such as a dynasty trust. The grantor then conveys the premiums by gift to the third-party owner when they are due.

The trustee can make distributions to the trust’s beneficiaries based upon the trust’s provisions. To maximize the value of the trust, the trustee may purchase a life insurance policy on the grantor’s life and use trust assets to pay premiums. The tax-free death benefit proceeds that would be received upon the deaths of the grantors would further magnify the value of the trust’s assets.

A dynasty trust offers an effective way to both maintain and retain wealth within a family for generations of beneficiaries, especially if there are beneficiaries who are minors or who lack investment management skills. When life insurance is used, the value of the family legacy can be further magnified on a tax-free basis. This technique may also provide creditor protection in certain states. And the trust can incorporate spendthrift provisions to guard against irresponsible spending.

Finally, grantors often include certain incentive provisions in the trust document to reflect their own values and ultimate wishes for beneficiaries and future generations. Incorporating such provisions can shape the conduct of beneficiaries and guard against adverse lifestyle choices or those choices which would be frowned upon by the grantor.

What Are Intentionally Defective Grantor Trusts?

Attorneys will often design dynasty trusts to be of a type called Intentionally Defective Grantor Trusts. The trust is intentionally defective because the grantor has retained one or more certain ownership rights in the trust. Ordinarily, an irrevocable trust is considered a separate entity for gift and estate tax purposes and no ownership interest in the trust is retained. Assets in the trust will continue be excluded from the grantor’s estate for estate tax purposes.

However, due to the retained ownership rights, the grantor and the trust are considered the same entity for income tax purposes. As a result, the grantor is taxed on any trust income and the trust avoids trust income tax liability. If the grantor pays any trust income tax liability, the trust retains more of its assets and the trust value can increase faster.

Drafting an intentionally defective trust also allows for more flexibility in dealing with the trust assets. For example, since the trust is not a separate entity for income tax purposes, a sale by the grantor of assets to the trust will not be a taxable recognition event for the grantor.

The need for informed legacy planning is growing. Dynasty and incentive trusts provide opportunities for clients to carefully plan out their legacies and the enduring effect they will leave on their family and the world.

Protect Yourself, Your Family and Your Business

Your estate plan should be designed to accomplish your personal, family, business and financial goals. If your assets are potentially subject to federal estate tax, minimizing taxes remains an important related goal. We would welcome the opportunity to work with you now to achieve your personal estate planning goals, and to take advantage of available tax planning opportunities. We also encourage you to contemplate critical non-tax choices, and to give your decisions legal effect through an appropriate combination of living wills, powers of attorney, health care agent appointments, gifts, wills and trusts.

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