By James R. Robinson and Stephen B. "Bo" Wilkins
In the space of not much more than ten years, the trusts and estates practice, particularly for high-net-worth clients, has undergone tremendous, even fundamental, change. In that time, two of the major historical constants on long-term planning-the temporal limitations of the trust form as dictated by the Rule Against Perpetuities, and the inability of a trust settlor to avail him- or herself of spendthrift protection-have been undone in a growing number of jurisdictions. These developments, combined with the diminishing (although still important) role of wealth transfer taxes and a shift in focus by the most forward-thinking families and family offices toward a long-term "endowment" model that regards taxes as one of many risks to be managed (and often not the most significant), have presented new challenges, and new opportunities, for planners. With the removal of those two ancient limitations, we now find ourselves asked to create perpetual structures designed to sustain a family's wealth and legacy for generations.
This article examines these developments, and the effects we have seen on our own high-net-worth practices over the past several years. In addition, we offer several observations both as to some of the practical issues involved in designing and implementing perpetual and self-settled trusts, and as to the possibility of leveraging wealth transfer through selected strategies, including GRATs, sales to defective grantor trusts, and life insurance.
Introduction: The Family Endowment
In 2005, the Family Office Exchange (FOX) held its second "Thought Leaders Program," a multidisciplinary panel discussion designed to identify and explore the concerns and issues facing wealthy families. The particular focus of the program was "understanding, measuring and managing uncertainty for families of significant wealth."1 The panel's conclusions, compiled as "Recasting the Central Role of the Family Office as Risk Manager," identified the changing role of the family office.
In brief, the panel concluded that the role of the family office is undergoing a "fundamental shift," from investment or wealth management to risk management, and assuming the role of the family's principal risk management agent. The panel identified four broad categories of risk: (1) business ownership and control; (2) wealth preservation and enhancement; (3) financial security and compliance; and (4) family continuity and governance.2 Each of these broad categories subsumes numerous examples of more specific risks, such as concentrated equity positions, personal health and wellness, and legal exposure. The broader point is that the central role of the family office-and, by extension, of the family's financial, legal and other professional advisors-is increasingly becoming one of identifying, implementing and maintaining structures, mechanisms and processes that preserve family wealth through risk management.
In one sense, there is nothing particularly new about this process. At some point, an individual or a family may accumulate sufficient wealth that the foreseeable needs of the senior generation are met-assuming proper management of risk. The focus turns from wealth accumulation to wealth preservation, not only for the current generation, but for succeeding generations as well.
Certainly, more than just financial considerations inform, and are important to, this dynamic. Shared values and goals, transmitted down the generations, may be the primary consideration for a number of families, and may be what the senior generation identifies as its legacy. Our focus in this article, though, is what might be called the "financial family," that is, the family as an economic unit. For the coherence of the financial family-and, indeed, for the sustainability of the other aspects of the family's legacy-a sustainable pool of wealth, or endowment-is of major importance, if not essential. Indeed, the shift in focus from accumulation to preservation might best be characterized as a shift to "endowment thinking," to thinking of one's wealth as a patrimony that can be sustained over multiple generations and provide the family with a secure financial base without destroying the family's initiative or compromising its shared values.
The Perpetual Trust As Endowment Platform
The establishment of a long-term, or even perpetual, fund requires enabling financial and legal structures. The prototypical legal structure for the establishment of a sustainable pool of family wealth is the discretionary spendthrift trust. However, the lifespan of the trust historically has been, and largely continues to be, limited by the Rule Against Perpetuities (the "Rule" or "RAP") long after the Rule, or any other durational limit, has ceased to apply to other entities such as partnerships and corporations.
Consistent with Robert Sitkoff's characterization of the jurisdictional competition for trust funds as an "interest group" process,3 several states, in their efforts to attract investments and fiduciary business, have responded to the need for enabling structures in two principal, related ways. Since the mid-1990's, and particularly since Delaware's repeal of the Rule in 1995, we have seen a remarkable, and remarkably rapid, erosion of the Rule. An increasing number of states have either eliminated it altogether or extended it into virtual irrelevance, thereby permitting the creation of a private endowment in the form of a perpetual or "dynasty" trust.4 Second, they have facilitated the management of risk and the preservation of assets, not only for future generations, but for the current one as well, in the form of the self-settled asset protection trust: the domestic asset protection trust or "DAPT." Taken together, these two vehicles provide the optimal, if not ideal, framework for the preservation and perpetuation of family wealth.
The apparent winner, at least to date, in this competition for trust funds has been Delaware.5 Although a few states before Delaware did allow perpetual trusts, in our opinion Delaware's position as jurisdiction of choice among "non-RAP" states is attributable to two main features: (1) no state income tax on undistributed trust income, and (2) a streamlined trust code whose principal characteristics are flexibility and freedom of contract. These features, combined with the repeal of the RAP, have led to what Sitkoff has characterized as a movement of between $100 billion and $200 billion in personal trust assets to Delaware and similar states (e.g., Alaska, Nevada and most recently Tennessee) and the death of the RAP.6