Pitfalls of Dynasty Trusts

Congress set the stage for dynasty trusts in 1986 when it instituted the generation-skipping transfer tax and allowed for a $1 million exemption. Estate planners began drafting trusts to take advantage of this exemption, but the term was always limited by the rule against perpetuities.

States saw an opportunity for revenue: if their state did away with the rule against perpetuities, they could attract business by offering tax-exempt trusts that could benefit generations forever. One study shows that this plan worked–nearly $1 billion in trust funds has been transferred to states that repealed their rule against perpetuities.

What are the potential downfalls of dynasty trusts?

• Too much money passes from generation to generation without being taxed. Dynasty trusts can easily grow to hundreds of millions of dollars, and all of this money is tax-exempt.
• With a spendthrift clause, beneficiaries are free to act as reckless as they wish, knowing that their creditors can never reach the trust money.
• Children who inherit large masses of money without working won’t make the most out of their lives.

See Ray D. Madoff, America Builds an Aristocracy, W.S.J., July 9, 2010.