Nine new millionaires are minted every minute in the United States, according to figures from the Federal Reserve. There are now nine million households with a net worth of $1 million or more, including many households with $5 million to $25 million.
Many of these new millionaires are baby boomers. Like the Depression-era generation, many of today's affluent boomers are thinking about how they can use their wealth to leave a financial legacy for their families. They are gravitating to dynasty trusts to accomplish what are often multiple-generation wealth transfer goals.
Unlike previous generations, though, boomers are looking to use dynasty trusts to make the future brighter not only for succeeding generations but also for the previous generations. They are reaching back to help their parents and sometimes even their grandparents.
Ultrahigh-net-worth boomers and Gen Xers are using dynasty trusts to help make their parents more comfortable, providing them with additional retirement income, buying them luxury homes or condominiums and setting aside assets for upscale long-term or chronic care.
Meanwhile, they retain responsibility for putting their children and sometimes their grandchildren through college, helping succeeding generations get off to a good start in life and providing opportunities they themselves may not have enjoyed. Tackling these multigenerational financial responsibilities places many boomers squarely in the middle of what many are calling the "Sandwich Generation."
Complications Of Multiple-Generation Planning
Including parents as current beneficiaries poses some unique considerations in designing and implementing a dynasty trust. The core strategy of creating a dynasty trust, however, remains the same: maximization of the generation-skipping transfer tax (GSTT) exemptions. Using life insurance to fund a dynasty trust is an easy method of leveraging GSTT exemptions. Essentially, clients gift cash equal to their available lifetime gift tax exemption to a dynasty trust and allocate their GSTT exemptions to the transfer, thereby creating a zero inclusion ratio. The trustee then uses the dollars gifted to the trust to purchase life insurance on the life or lives of the grantors, enabling all of the death benefit to be paid free of federal income and estate tax to the dynasty trust upon the death of the insured(s).
Another approach to leveraging the benefit of a dynasty trust is to sell highly appreciating and/or income-producing assets to a trust in return for a promissory note. This technique is favored by donors, especially baby boomers and other younger millionaires, who want to be able to watch their family enjoy the transfer of wealth.
In most circumstances, the sale transaction can be viewed as two parts. First, the grantors use all or a part of their available lifetime gift tax exemption(s) to make a substantial gift to the dynasty trust. They also allocate their available exemptions to this gift so that the trust can be exempt of the GSTT. This initial gift can be made with cash or with other property. After the gift is completed, the trustee purchases rapidly growing and/or income-producing assets from the grantors in return for a bona fide promissory note. The benefits of this technique are only realized if the assets sold to the trust (together with the initial gift amount) outperform the interest rate on the note. Any growth or income in excess of the interest requirement on the note remains in the trust for the trust beneficiaries. To enhance the likelihood of removing more assets from the grantor's estate than the grantor retains in the value of the note interest and principal, the assets sold to the trust are typically assets that can be discounted for a lack of marketability or lack of control, such as limited partnership interests or nonvoting S-corporation stock.
To better understand how this all works, let's consider an example.
Assume Claudia, age 57, uses her lifetime gift tax exemption to gift $1 million of cash to her dynasty trust. She subsequently sells $5 million of limited partnership units to the same trust in return for a 5% interest-only note with a balloon payment due at the end of a specified term. In order to satisfy the note obligation, the trustee must earn $250,000 on the trust assets (5% of $6 million). Without any discount, the trust's assets would have to earn approximately 4.2%.