Dy n a s t y Tru s t Producer Guide For producer use only. Not for distribution to the public.
Dynasty Trusts The following overview provides general information on the design and operation of Dynasty Trusts and incentive provisions, current as of September 2007. Please note that all documents must be drafted by legal counsel. Additionally, qualified advisors who are knowledgeable in the area must provide any needed professional services such as accounting or tax advice. Overview of Dynasty Trusts Many high net worth individuals wish to leave an ongoing legacy to their grandchildren without dramatically reducing their children s inheritance. This may be accomplished by effectively leveraging the generation-skipping transfer tax (GSTT) exemption. One of the most effective ways to do this is to use a Dynasty Trust to pass as many assets as possible to the grandchildren. Benefits of Dynasty Trusts A Dynasty Trust, also known as a legacy or generation-skipping trust, can be a tax-effective way to transfer significant assets to beneficiaries. While it is an irrevocable life insurance trust (ILIT), a Dynasty Trust goes a step beyond a standard ILIT in that it can last over several generations. Rule Against Perpetuities A Dynasty Trust will continue for as long as the rule against perpetuities will allow. In jurisdictions that have adopted the Uniform Statutory Rule Against Perpetuities, a Dynasty Trust can endure for the common law perpetuities period or 90 years. A Dynasty Trust goes a step beyond a standard ILIT in that it can last over several generations. In those states that have abolished or greatly extended the rule against perpetuities, 1 a Dynasty Trust can last beyond the limit imposed by the common law perpetuities period. Of these states, Alaska, Delaware, Florida, South Dakota, and Wyoming are considered the most desirable locations for these types of trusts because of their favorable asset protection and income tax laws. 1 Currently these states include Alaska, Arizona, Colorado, Delaware, Florida, Idaho, Illinois, Maine, Maryland, Missouri, Nebraska, Nevada, New Hampshire, New Jersey, Ohio, Rhode Island, South Dakota, Utah, Virginia, Washington, Washington, D.C., Wisconsin, and Wyoming. t r a n s a m e r i c a 1
Life insurance as a trust asset can be an effective way to leverage trust contributions because they can be used to purchase a sizable life insurance policy. Estate Tax Considerations When the trust is properly drafted by legal counsel, the trust s assets including life insurance owned by the trust may remain free from federal gift and estate taxes for the life of the Dynasty Trust. Under current federal law, no estate tax is due at death if the taxable estate is less than $2 million in 2007 or 2008, increasing to a maximum of $3.5 million in 2009. In 2010 no federal estate taxes will be assessed; however, in 2011 the estate tax exemption will revert to the 2001 level of $1 million. Understanding Generation Skipping Transfer Taxes In 1986, Congress created the GSTT. Under current federal tax law, a GSTT is imposed on any transfer of property by gift, or at death, to any person who is two or more generations below that of the transferor or 37 1 /2 years younger than the transferor. For example, in the case of family members, this includes the transferor s grandchildren as well as great-nieces and great-nephews. The GSTT is applied to the Dynasty Trust by assuming that the trust beneficiaries own the assets in the Dynasty Trust. A flat tax equal to the highest estate tax bracket is imposed on every generation-skipping transfer. There are a number of exceptions to the GSTT: n Tuition and medical payments when made directly to the provider n $12,000 annual exclusion in 2007 for present interest gifts 2 n $2 million lifetime exemption per transferor in 2007 and 2008 2 The annual gift tax exclusion amount is indexed for inflation annually in $1,000 increments. 2 Dynasty Trust
Producer Guide Gifts of the $12,000 annual exclusion amount may be used to pay the premium on a life insurance policy owned by a Dynasty Trust. Alternatively, the $2 million GSTT exemption may be utilized in conjunction with the $1 million lifetime gift exemption. In either case, life insurance as a trust asset can be an effective way to leverage trust contributions because they can be used to purchase a sizable life insurance policy. However, since the current lifetime gift tax exemption is limited to $1 million per transferor and is not scheduled to increase, transfers in excess of $1 million to a Dynasty Trust will be subject to gift tax. Therefore, it may be desirable to limit the use of the GSTT exemption to the $1 million maximum lifetime gift exemption when contributing funds to the Dynasty Trust. Future Tax Advantages The GSTT, like the estate tax, is scheduled to be repealed for 2010. This means that, without legislative action, it will return in its pre-egtrra Scheduled Tax Changes Lifetime Estate Tax Gift Tax GSTT Year Exemption Exemption Exemption 2008 $2 million $1 million $2 million 2009 $3.5 million $1 million $3.5 million 2010 N/A $1 million N/A repealed repealed 2011 $1 million $1 million $1,120,000 * * Plus increases for indexing for inflation after 2003. form on January 1, 2011. 3 If the GSTT exemption is properly allocated to the contributions to the Dynasty Trust, it is likely that the trust assets will never be subject to the GSTT. Note, however, that income tax may be due on trust distributions. If the GSTT exemption is properly allocated to the contributions to the Dynasty Trust, it is likely that the trust assets will never be subject to the GSTT. 3 EGTRRA is the Economic Growth and Tax Relief Reconciliation Act of 2001. t r a n s a m e r i c a 3
Establishing the Dynasty Trust A Dynasty Trust should be drafted by an experienced estate planning attorney after a thorough analysis of the client s objectives. The trust can be created during a grantor s lifetime or upon his or her death. Life insurance death benefit proceeds magnify trust assets through leverage of premium amounts. In the following example, the trustee pays the premiums on a life insurance policy with annual split gifts from the two grantors of $24,000 per grandchild. In order for the gifts to qualify for the annual gift and GSTT exemption, it is important for the beneficiaries to be given withdrawal rights, commonly referred to as Crummey powers. These powers to withdraw gifts placed in the trust are only exercisable during a specific period of time for example, for 30 days after receiving the Crummey notice. The $2 million gift can be used as the source of income and/or principal payable from the Dynasty Trust to the grandchildren during the grandparents lifetimes, or to supplement the annual gifts to pay the life insurance premiums. Ownership/Beneficiary Arrangements In establishing a Dynasty Trust funded with life insurance, there are a number of ownership and beneficiary issues to consider. n Estate Exclusion If the insured had no incidents of ownership in the life insurance policy at any time within three years prior to his or her death, the policy proceeds will not be included in the insured s taxable estate. To assure that the life insurance policy is excluded from the grantor s estate, the original policy applicant should be a third party, such as the trustee of the Dynasty Trust. The grantor would then gift the premium to the thirdparty owner. 4 Dynasty Trust
Producer Guide Dynasty Trust Grandparents Grantors Create trust with gift of $2 million ($1 million each) using lifetime gift tax exemption and allocating a portion of GSTT exemption. Annual gifts of $24,000 per beneficiary (can be split gifts if separate property). Children & Grandchildren Beneficiaries Trust may make distribution of income and/or principal. Such distribution may be based upon incentive provisions. Dynasty Trust Trust purchases survivorship life insurance policy on lives of grandparents. Death benefit proceeds magnify trust assets through leverage of premium amounts. Life Insurance Policy n Gifting to the Dynasty Trust By using the current annual gift exclusion of $12,000 per beneficiary, grantors may provide the funds needed to purchase a life insurance policy. This exclusion allows each grandparent to make a $12,000 gift to any one donee, which means the grandparents can make a joint gift of up to $24,000 a year to any one individual. For example, in an instance where married grandparents have five grandchildren, they could jointly gift a total of $120,000 per year. Joint gifts need not come from both spouses property. The entire $24,000 could be made from one spouse s separate property, provided the other spouse consents to split the gift. Grandparents can make a joint gift of up to $24,000 a year to each individual. t r a n s a m e r i c a 5
Example: The Buck Family Bill and Barbara Buck, both 65, have one daughter Susan. Susan is financially comfortable in her own right. They also have three teenage grandchildren: Tom, Eileen, and James. The Bucks have a substantial estate and want to pass their wealth on to their descendants without paying a federal transfer tax. There are a number of incentive provisions that can be added to the Dynasty Trust to provide a blueprint of the grantor s own values. After consulting with their financial advisor, a life insurance professional, and an attorney experienced in estate planning, Bill and Barbara decide to create a Dynasty Trust. The Bucks transfer $2 million (each using $1 million of their lifetime GSTT and gift tax exemptions) to the trust that will pay income to Susan s children for their lives, and on to successive generations until the expiration of the perpetuities period. The trust assets, as well as their appreciation and accumulated income, will not be subject to federal gift and estate taxes for the entire term of the Bucks Dynasty Trust. In addition to the $2 million gift to the trust, the Bucks gift an additional $72,000 to the trust using their annual gift and GSTT exclusion to fund the purchase of a $6 million survivorship life insurance policy that will pay a death benefit at the death of the surviving spouse. Because Bill and Barbara think Susan s children are a bit wild and undisciplined, they also include incentive provisions in the trust to ensure that the grandchildren meet certain behavioral and lifestyle standards before they are allowed access to the trust s substantial assets. 6 Dynasty Trust
Producer Guide Adding Incentives to the Trust Many people who have worked hard to earn and build their wealth are reluctant to leave it to beneficiaries who may be carefree in their spending or who do not share the same values as the donors. There are a number of incentive provisions that can be added to the Dynasty Trust to provide a blueprint of the grantor s own values. These incentives will ensure that beneficiaries meet certain goals before they receive funds from the trust. Let s look at how incentive provisions can help improve the lives of the Buck grandchildren. Tom the eldest grandchild is ambivalent about attending college. Bill and Barbara, however, have strong feelings about a college education and have included an incentive in the trust to address this. On the day that Tom graduates from college, the trust will pay him $50,000. This gift is not specific to Tom. Any grandchild will be eligible to collect a $50,000 gift upon graduation. Likewise, James their youngest grandson is working to purchase his first car but would rather play basketball. To give him an incentive and to help him reach his goal more quickly, Bill and Barbara decide to incorporate trust language that will match his earnings by 50%. Of the three grandchildren, their granddaughter Eileen has an exemplary academic record and appears to be driven to succeed in her chosen career. While Bill and Barbara are proud of her success, they feel family values are important and would like to see her get married. As soon as Eileen gets married, she receives a $100,000 gift from the trust. A Dynasty Trust can help clients leverage their GSTT exemption. Note that some provisions might not be legally enforceable. For example, it s unlikely that an individual would be able to disinherit a beneficiary if the provision were such that he or she never marries. But a provision may be added to the Dynasty Trust limiting annual distributions to a certain amount such as $5,000 if the beneficiary marries a specific person. Achieving Important Goals A Dynasty Trust can help clients leverage their GSTT exemption while they are alive, and create a long-lasting legacy for future generations by sheltering not only the value of the assets transferred, but also any appreciation of those assets. For more information about this and other advanced marketing strategies, be sure to visit our Web site at www.tatransact.com, or speak to our Advanced Marketing consulting team by calling 1-877-ADV-MRKT (238-6758). t r a n s a m e r i c a 7
This material was not intended or written to be used, and cannot be used, to avoid penalties imposed under the Internal Revenue Code. This material was written to support the promotion or marketing of the products, services, and/or concepts addressed in this material. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely solely on their own independent advisors regarding their particular situation and the concepts presented here. Transamerica Life Insurance Company, Transamerica Financial Life Insurance Company (collectively Transamerica ), and their representatives do not give tax or legal advice. This material and concepts presented here are provided for informational purposes only and should not be construed as tax or legal advice. Although care is taken in preparing this material and presenting it accurately, Transamerica disclaims any express or implied warranty as to the accuracy of any material contained herein and any liability with respect to it. This information is current as of September 2007. Life insurance products are issued by Transamerica Life Insurance Company, Cedar Rapids, IA 52499, or Transamerica Financial Life Insurance Company, Purchase, NY 10577. All products may not be available in all jurisdictions. Transamerica Financial Life Insurance Company is authorized to conduct business in New York. Transamerica Life Insurance Company is authorized to conduct business in all other states. OLA 1376 T 1008 Dynasty Trust Producer Brochure For producer use only. Not for distribution to the public.