A regular part of planning for high net worth families are dynasty trusts – long term multi-generational trusts that are exempt from generation skipping tax. The trusts are more attractive than ever, with expanded generation skipping tax exemptions ($5.25 million in 2013) and an extended or eliminated rule against perpetuities provisions in many states.
The typical thought is that these trusts will grow and service many generations of beneficiaries. Hugh Magill, the Executive Vice President and Chief Fiduciary Officer of Northern Trust has combined Northern Trust’s data from its many years of trust administration and some modeling, and gleaned some observations about how such trusts actually operate, and might operate in the future. Some of his observations (mixed in with a few of my own) that may challenge your assumptions about dynasty trust include:
A. The number of beneficiaries will multiply faster than you think. With some reasonable assumptions about child-bearing ages and each family unit having two children, in 50-60 years time a pot trust could have as many as 30 current beneficiaries. As time progresses, the number increases potentially so that if a trust lasts for a very long time (as some may anticipate), it could have as many as 160,000 to 500,000 beneficiaries! As Hugh speculates, who would want to be trustee of that trust?! Obviously, the more beneficiaries there are, the quicker the trust will be depleted (depending on distribution standards used). Having an early termination of the pot trust via a break up into separate per stirpes trusts will reduce this, but will still result in continual subdivision and shrinkage of each trust as they pass through the generations. Hugh also raises the question of fairness – at what generation level would it be more equitable for a pot trust to divide per capita (equally per beneficiaries) rather than per stirpes?
B. Applying some Monte Carlo modeling and assumptions, a median result for a $5.25 million dynasty trust established in 2012 estimates growth to $9.8 million in 2029, and then it starts to decline, reaching $4.1 million in assets by 2071. However, these are 2012 dollars – if inflation is considered, that $4.1 million will be worth much, much less than $4.1 million in today’s dollars.
C. If the trust is a grantor trust, that will boost the return somewhat since it will have a few years of not being taxed at the beginning of its life, but that treatment ends when the grantor dies. This treatment augments the median value estimate to $5.3 million in 2071.
D. Note, however, that these projections involve a diversified portfolio of marketable assets and securities. If the trusts are funded with discounted assets and/or highly appreciating assets, the growth of the trust and its size over time can be substantially increased.
E. Payout standards will also impact how long the trust will maintain significant assets – obviously, the more that is paid out in distributions, the fewer the assets that will remain and grow in the trust. Planners may want to consider scaling back from mandatory income, significant unitrust, and/or HEMS distributions after a generation or two to help the trust maintain its assets – perhaps limiting distributions to health and education purposes.
The fact that a dynasty trust may not last as long as originally anticipated may not be of much concern to many grantors. While there are those grantors who are looking to carry the trust as far into the future as possible (especially in very high net worth families), many grantors will not even have known what a dynasty trust is when they first walk into their lawyer’s office. Such grantors will often have no problem with such trusts exhausting themselves sooner, rather than much later.
Thanks to Hugh Magill for his work and observations, and his permission to me to attempt to restate them here – and my apologies in advance to Hugh if I have incorrectly summarized any of his points.