Dynasty Trusts

An American aristocracy?:

America Builds an Aristocracy, by Ray Madoff, Commentary, NY Times: Americans have always assumed that wealth comes and goes. A poor person can work hard, become rich and pass his money on to his children and grandchildren. But then, if those descendants do not manage it wisely, they may lose it. “Shirtsleeves to shirtsleeves in three generations,” the saying goes, and it conforms to our preference for meritocracy over aristocracy.

This assumption is now being undermined, however, through the increasing use of so-called dynasty trusts. These estate-planning instruments enable affluent people to provide their heirs with money and property largely free from taxes and immune to the claims of creditors ... for generations in perpetuity — truly creating an American aristocracy. ...

This type of trust is new because until very recently most states had a “rule against perpetuities,” which limited the term of any family trust to about 90 years... In the mid-1990s, however, many states repealed the perpetuities rule...

What caused state legislatures to abandon a rule that had existed since the late 1600s? ...Congress ... set the stage nearly 25 years ago. In 1986, Congress instituted the generation-skipping transfer tax. This closed a loophole in the estate tax... However, in enacting this tax, Congress gave each taxpayer a $1 million exemption, which was raised over the years to $3.5 million.

Naturally, estate planners began to create trusts that could ... avoid taxes for the term of the trust. The term, however, was limited by the rule against perpetuities.

Bankers then realized that if they could persuade their state legislatures to repeal that rule (as well as state income taxes on trusts), they could attract business. And in more than a dozen states the banking lobbyists were successful..., and dynasty trusts ... were born. This did generate business. ...

Dynasty trusts can grow much larger than the $3.5 million exemption amount would suggest. A couple can, for example, put $7 million (their two $3.5 million exemptions) into a life insurance policy owned by the trust. The... trust is forever free from taxes — even when, after the death of the second spouse, the life insurance policy pays off at $100 million. Alternatively, a trust can use the $7 million as seed money for a profitable business that the trust then owns. ...

But tax breaks are not the only special advantages that dynasty trusts provide. Even more troubling, they commonly include a “spendthrift clause,” which provides that trust assets cannot be reached by a beneficiary’s creditors. If a beneficiary causes a car accident, for example, the victim cannot be compensated with assets from the trust, even if they are the driver’s only resources. So beneficiaries are free to behave as recklessly as they like, knowing that their money is forever protected for themselves and their heirs. ...

Congress could fix the problem... Then America would not have to face the uncontrollable growth of a new aristocracy.

Congress could fix it, but will it actually do so? To me, this says a lot about where our political system has devoted its effort in recent decades. It takes valuable legislative time, staff effort, etc. to implement new legislation such as this, time that could have been spent on other pressing issues. Yet these are the kinds of things -- enabling the creation of a permanent wealthy class -- that legislators carved out time to do. There were still other issues on the legislative agenda, of course, but this is an example of how legislative effort has shifted in recent decades to satisfy particular political interests.