How to Use Dynasty Trusts in Modern Asset Protection & Estate Planning

Posted by: Joel M. Nagel    Posted Date: Wed, 06/14/2017 - 12:00am

Categories: Estate Planning

The development of the modern-day trust stems from the early Middle Ages during the time of the Crusades when wealthy knights went off to liberate Jerusalem for Christendom. It is the oldest form of legal "structure" or creation of a juridical person under English Common law predating partnership and corporations by hundreds of years.

The earliest English courts of “equity” (or fairness) in the 12th Century held that assets could be alienated to benefit heirs or be set aside for a special purpose even when a legal "contract" (with consideration by both parties) did not exists. 

Soon thereafter, the King of England sought limitations on how long a trust could be in “effect.” Since the King collected a tax from his nobility at the time of their death, the trust was a vehicle to circumvent those early “death taxes.” 

Eventually, the common law developed in such a way that a trust could not be in effect longer than “a life in being plus 21 years.”

The Rule Against Perpetuities

This is still the basic rule in most U.S. states and is referred to as the “rule against perpetuities,” meaning that you must leave your assets to persons, charities, etc., and the disposition must be completed within 21 years after the measuring life (i.e., children, grandchildren, etc.).

You can't leave your property in this type of legal structure "into perpetuity" (i.e. forever).

Some States, as well as numerous financial centers or “tax havens,” have legislatively repudiated this basic common law concept. Many select specific periods of years for which a trust can be in effect, most commonly 100 years. 

In some cases, the term is even longer, such as Nevada, which now permits trusts for 365 years and South Dakota where trusts may be perpetual.

How a Dynasty Trust Works to Preserve Wealth

Any jurisdiction that legislatively allows for a specific period beyond the English common law “life in being plus 21 years,” whether for a term or perpetual, is referred to as a jurisdiction which permits “Dynasty” Trusts. 

“Dynasty” trusts are designed to be in effect for longer than two generations.

In the case of extremely wealthy families, a “Dynasty” trust is often married together with another vehicle referred to as a “Family Office.” 

The purpose of those vehicles working together is to steward family wealth over many generations rather than simply pass on wealth from one generation to the next for consumption.

The “Dynasty” trust limits who can access trust assets, when and for how much.  Frequently, only the income of the trust may be accessed and for a specific purpose, while the overall corpus is left intact for future generations. 

Sometimes, beneficiaries can only borrow funds which must be repaid or a beneficiary can only seek venture capital for which the trust receives “equity” in return.

Through these types of limitations or safeguards, the family wealth is protected, preserved and allowed to grow, while each successive generation may only access the funds in a way that they are not diminished.

How to Use Life Insurance within a Dynasty Trust

Another frequent tenant of Dynasty Trusts is the use of life insurance within the trust, at each generational level (or every other generation) to ensure that there are always assets within the trust.

Frequently, a relatively young and healthy adult is selected to be the"measuring life" of the insurance policy for two reasons.

First, the cost of the death benefit is relatively low because of the insured's health and age, and secondly because the time in which assets within the policy can grow (actuarially) on a tax-deferred basis is very long.

This allows for the magic of tax-deferred compounding to achieve its maximum effect.

Additionally, whenever the life insurance is finally paid out, it receives tax-free treatment under the tax code (life insurance proceeds are not taxable), meaning that the dynasty trust's assets get replenished at least once every generation or every other generation, which is an important element of any trust's ability to function over multiple generations.

Discover the Difference Between Domestic and Foreign Trusts

Most people structure their asset protection and estate planning affairs in their home country; however, more and more people are looking to international solutions for a variety of reasons. 

Those reasons include:

  1. Global Diversification:  Many international banks, brokerage houses, hedge funds, mutual funds and even individual shares in foreign companies are closed to U.S. investors. A foreign trust is considered a “juridical person” whose nationality is determined by where the trust is established and registered.

    The foreign trust can therefore open up financial doors to investments and financial accounts which are presently closed to U.S. persons.

    This category currently represents approximately 70 percent of the world's equities.
     

  2. Better Asset Protection:  While Tennessee, Alaska, Nevada, Delaware and South Dakota vie to have the most protective trust features in the U.S., legislation granting creditor protection as well as extending the trust term from traditional common law norms into the “Dynasty” arena are all fairly new and legally untested.

    Undoubtedly, these protection provisions will be challenged on the grounds of the “Full Faith & Credit” clause as well as the “Supremacy” clause of the U.S. Constitution. This is because the Constitution requires a state to enforce the laws of other states or put the federal laws above the laws of the individual states. 

    These Constitutional concepts undermine the ability of any particular state with regard to enhancing asset protection beyond common norms accepted historically by the Common Law as well as the majority of states. 

    In the case of federal bankruptcy, for example, state asset protection will certainly give way to federal rules interpreted by federal (not state) judges.

    This means that while long term dynasty trusts can be created in the U.S., the value of their protection is at best unclear.

    In the international or “offshore” arena, the “Full Faith and Credit,” as well as “Supremacy” clauses of the United States Constitution, do not apply as between the U.S. and foreign countries. 

    In fact, most asset protection jurisdictions specifically reject the notion that any judgment from another country is enforceable in its jurisdiction. 

    Therefore, the only way to go after assets in a foreign jurisdiction is to initiate litigation in that jurisdiction, which is frequently very difficult and expensive, if not impossible to do.
     

  3. Better Confidentiality and Estate Planning: Frequently trusts registered in foreign jurisdictions are not subject to having the grantors’ or beneficiaries’ identities listed in any sort of public registry.  While most individuals still need to disclose the information to their own tax authorities, the ability of a potential plaintiff to determine what you own or to levy litigation against the asset is virtually eliminated. 

    The same confidentiality also applies to children, grandchildren and more remote heirs who have no right to know what they potentially have access to in the future until such time that the trust document permits disclosure to them. This information may become known to them at a certain age or after the proceeding generation has all died or upon another triggering event as desired by the trust grantor.
     

  4. Global Hedging and Diversification:  Not only does an international trust open doors closed to most Americans, it can also minimise risks associated with “having all of your proverbial eggs in one basket.” 

    International trusts allow for better global diversification in assets, investments and currencies, and they generally have a global investment mandate. They can also protect against political risk, regulatory and tax changes, as well as the risk of future capital and currency controls. 

    For many Americans, this “hedging” is like buying an insurance policy you hope you never need.

    Many financial studies have shown that true global diversification can bring about overall higher investment returns, while introducing less risk and volatility into the investment portfolio.

    When managing assets over many generations, achieving higher returns with lower volatility and risk is exactly what the bank or trust company (and presumably also the beneficiaries) want to see with regard to the stewardship of their wealth.
     

  5. Tax Issues:  While most tax benefits of trusts have been eliminated, there are still a few things worth mentioning.

    Both domestic and foreign trusts are capable of receiving up to $5,430,000 per person, gift and estate tax free. This number is indexed for inflation and will increase every year unless changed by Congress.

    That means $10,860,000 per married couple can go into a foreign or domestic trust without a direct gift or estate tax consequence. 

    In the case of a foreign “Dynasty” trust, once the U.S. grantor/settlor dies, there is no immediate taxation of the foreign trust on its present earnings until a direct distribution to a U.S. heir beneficiary occurs. 

    The trust, when structured as a "completed gift" (as opposed to an incomplete gift) is also not part of any U.S. taxpayer’s taxable estate, meaning that it is not subject to estate taxes at the death of the grantor or any future beneficiary. 

    To the extent that the trust goes on for many years and numerous generations, it can potentially avoid the effects of the estate tax at each successive generation and thereby keep more assets inside the trust for productive income generation and overall wealth preservation and growth.

Secure Your Family’s Wealth from Generation to Generation

The “Dynasty trust” is a tool used by moderately wealthy to ultra-high net worth individuals who wish to limit any one beneficiary’s access to trust assets and thereby perpetuate wealth over many generations. 

When used together with a family office structure, life insurance and other long-term wealth preservation tools such as real estate, gold, timber, and commodities, the “Dynasty” trust is perhaps the very best method of stewarding wealth beyond merely one or two generations. 

International “Dynasty” trusts add the additional features of global access, global diversification and hedging of the economic, financial and political risks associated with maintaining all of one’s wealth in his or her home country. 

For those reasons, an international asset protection “Dynasty” trust should be considered by anyone wanting to leave an inheritance to their children, children’s children and beyond.

Joel M. Nagel is an international lawyer and entrepreneur focusing his practice in the area of asset protection, cross-border transactions, and global investment. He speaks all over the world on the topics of asset protection, global banking and investment, and international legal compliance.

Joel has written articles and has been quoted by Forbes, Fortune, Live and Invest Overseas, Hemispheres Publishing, Stansberry Research, Oxford Club, Pirate Investor, True Wealth, Islands magazine, Business Times, Physician’s Money Digest, and the Simon Letter. Joel can be reached at NagelLaw.com or +1-412-749-0500.