Multigenerational

From Generation to Generation

Each time you transfer wealth to another person, the transfer is potentially subject to federal transfer tax, in the form of gift or estate tax. The federal transfer tax system is designed to impose a tax on each and every generation (e.g., father to son, son to granddaughter, etc.).

The transfer tax system accounts for the fact that a transfer might “skip” a generation by passing from parent to grandchild, for example. This is accomplished by imposing an additional tax whenever transfers of wealth are made to persons who are more than one generation below the taxpayer. This additional tax is called the generation-skipping transfer tax (GSTT). GSTT is imposed at the highest estate tax rate in effect at the time of the transfer (45% in 2009). These taxes can take an enormous bite whenever wealth is being handed down, and eventually eat away a family’s fortune. This can be troublesome to individuals with substantial wealth who would prefer to have their legacies benefit their own family members. It’s from these circumstances that the dynasty trust (or Generation-Skipping Trust) evolved.

A Dynasty Trust is created to provide for future generations while minimizing overall transfer tax. With a Dynasty Trust, you would transfer assets to the trust. The trust then provides for future generations for as long as it exists. Although the trust assets effectively move from generation to generation, there are no corresponding transfer tax consequences.

Example

John and Mary, a married couple, own property with a net value of $3 million, which they would like to pass on to their children and future generations. Three potential scenarios are as follows:

Scenario 1: Mary and John leave $3 million outright to their two children.

Scenario 2: John and Mary leave $3 million to a trust for the benefit of their two children and then distributed to grandchildren.

Scenario 3: John and Mary leave $3 million to a Dynasty Trust created in a state that has no rule against perpetuities.

Assume that a generation is 26 years, the estate and GSTT exemptions are $1.5 million, the estate tax rate is 45%, the growth rate is 7%, principal is not spent, and state variables and income taxes are ignored.

In scenario 1, $3 million passes to John and Mary’s children free from estate taxes. In 26 years, the money grows to approximately $17 million, but after estate taxes are deducted, John and Mary’s grandchildren receive approximately $11 million.

In scenario 2, $3 million passes to the trust free from estate taxes. In 26 years, the money grows to approximately $17 million. 26 years after that, approximately $101 million is distributed to John and Mary’s grandchildren.

In scenario 3, $3 million passes to the Dynasty Trust free from estate taxes. In 26 years, the money grows to approximately $17 million. 26 years after that, the money has grown to approximately $101 million. And 26 years after that, the money has grown to approximately $587 million that will provide benefits to John and Mary’s great-grandchildren and beyond.

As you can see, the use of multigenerational estate planning techniques can provide massive benefits for growth and protection of your assets as they pass from one generation to the next. We have created many of these trusts for our clients over the years, and would be happy to talk to you about whether one of these plans would be a good fit for your family.

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With offices in Madison and Evansville, the attorneys at Wilson Law Group assist clients with Estate & Business Planning, Probate & Trust Administration, and Elder Law & Medicaid Planning throughout Southern Wisconsin.