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Dynasty Trusts: Long Term Trust Design
Community Foundation
November 14, 2013
R. Hugh Magill
Executive Vice President & Chief Fiduciary Officer
The NorthernTHE
TrustRIGHT
Company
- Rev. 10/2/2013
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Today’s Agenda: Long Term Trust Design
 Introduction
 Financial Sustainability
 Planning for Unique Assets
 Statements of Intent
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LONG TERM TRUST DESIGN
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Wealth Transfers After ATRA*
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 Introduction
 Under
current law, 2013 represents a continuing opportunity to transfer substantial wealth by
gift to family members, particularly through long term trusts designed to be exempt from the
Rule Against Perpetuities.
 The
Tax Reform Act of 2010 unified both exemptions and rates under the Federal Estate, Gift,
and Generation Skipping Transfer Taxes. ATRA preserved the unified exemption and rate
structure, with a modest marginal rate increase.
2011
Exemptions
Rate on Excess
$5,000,000
35%
2012
$5,120,000
35%
2013
$5,250,000
40%
 Leveraged
wealth transfer strategies such as the use of valuation discounts for unmarketable
and minority interests, short-term grantor retained annuity trusts, defined value clauses,
installment sales, and self-cancelling installment notes, among others.
 The
ability to obtain grantor trust treatment for fiduciary income tax purposes. See Revenue
Ruling 85-13, 1985-1 Cum. Bul 184. See also Sections 671 et seq. of the Internal Revenue
Code.
*American Taxpayer Relief Act of 2012
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Wealth Transfers After ATRA
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 Rule Against Perpetuities
 Approximately
29 states have either repealed, optioned or extended the permissible
period under the common law Rule Against Perpetuities (See Table A) making
these states a logical choice for the situs of a long-term family (or “dynasty”) trust.
Threats to perpetual trusts exist on several fronts:
 President Obama has proposed, in the General Explanations of the Administration’s Fiscal
Year 2014 Revenue Proposals (commonly referred to as the “Green Book” that the Federal
GST exemption to be limited in duration to a period of ninety years.
 The American Law Institute’s Restatement Third of Property (Wills and Other Donative
Transfers) – Volume 3 proposes limiting long-term trusts to no more than two generations
below the transferor. This approach is explained and amplified in the “The American Law
Institute Proposes a New Approach to Perpetuities: Limiting The Dead Hand to Two
Younger Generations.” Lawrence W.. Waggoner, University of Michigan Law School, Public
Law and Legal Theory Working Paper Series, Working Paper 200 (Revised July, 2010).
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LONG TERM TRUST DESIGN
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State Perpetuities Statutes
RULE**
Permits Perpetual Trusts
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STATES
Alaska, Delaware (for trusts of personal property), District of
Columbia, Idaho, Illinois, Kentucky, Maine, Maryland,
Michigan, Missouri, Nebraska, New Hampshire, New
Jersey, North Carolina, Ohio, Pennsylvania, Rhode Island,
South Dakota, Virginia, and Wisconsin
Permits Very Long Trusts
Alabama (360 years), Arizona (500 years), Colorado (1,000
years), Florida (360 years), Nevada (365 years), Tennessee
(360 years), Utah (1,000 years), Washington (150 years),
and Wyoming (1,000 years)
Follows USRAP
Alabama, Alaska, Arizona, Arkansas, California, Colorado,
Connecticut, District of Columbia, Florida, Georgia, Hawaii,
Indiana, Kansas, Massachusetts, Minnesota, Montana,
Nebraska, New Jersey, New Mexico, Nevada, North
Carolina, North Dakota, Oregon, South Carolina, South
Dakota, Tennessee, U. S. Virgin Islands, Utah, Virginia,
Washington and West Virginia
Iowa, Mississippi, New York, Oklahoma, Texas, and
Vermont
Louisiana
Follows Common-Law RAP
Termination at Later of Death of Last Income Beneficiary or
20 years after Grantor’s Death
**January, 2013
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Financial Sustainability
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Financial Sustainability
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 Financial Sustainability
 Financial
Modeling
 Many financial models used to illustrate the asset accumulation in long-term trusts
inadequately assess the impact of the two critical phenomena in trust management:
– The expansion of beneficial interests through generations
– The timing and extent of trust distributions tied to beneficiaries’ life stages
 Reproductive
Data
 The mean age of a mother at first birth is 25.2 years in the United States.
 Significant differences in age at first birth exist among U. S. States and among racial
and ethnic groups:
– Massachusetts has the highest average maternal age at first birth – 27.7
years
– Mississippi has the lowest average maternal age at first birth – 22.6 years
– Asia Pacific Islander women had the oldest maternal age at first birth - 28.5
years
– Alaskan native women had the youngest maternal age at first birth - 21.9
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Financial Sustainability
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 Fertility rates in the United States have declined over the last three generations, from
a high of 3.0 births per women, for women born in 1935, to 2.0 births per woman, for
women born in 1960.
– The total fertility rate (TFR) for the United States in 2009 was 2007.0 births
per 1,000 women.
 Statistical data on the average age difference between siblings are difficult to
interpolate from census data. I have assumed a three year gap between first and
second children for modeling purposes.
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LONG TERM TRUST DESIGN
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Family Tree
Husband (70)
2012
Wife (70)
Daughter (45) Husband
Grandson (15)
Son (40)
Granddaughter (12)
G-Granddaughter G-Grandson
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G-Grandson
Granddaughter (10)
G-Granddaughter G-Granddaughter
Wife
Granddaughter (7)
G-Grandson G-Grandson
G-Granddaughter
2027 2038
GGG Child
20572068
99 9
GGG Child
GGG Child
GGG Child GGG Child
GGG Child
LONG TERMTRUST
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LONGTERM
DESIGN
GGG Child
GGG Child
GGG Child
GGG Child
GGG Child
GGG Child GGG Child
GGG Child
GGG Child
GGG Child
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Financial Sustainability
 Modeling Assumptions
 Family Size – See Table
 Distribution Rates (Annual)
Years
Years
1 – 10
10 – 12
13 – 14
15 - 17
18 – 20
21 – 26
27 – 38
39 – end
0
1%
2%
3%
4%
5%
6%
7%
 Special Principal Distributions
– $100,000 in each of years 15, 18, 20, 23 (inflation adjusted)
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Financial Sustainability
 Capital
Market Assumptions – See Models
 Tax Assumptions
– Taxable Trust
Ordinary Income
2012
35%
2013 to end
43.4%
2012
15%
2013
23.8%
Capital Gains
– Defective Grantor Trust
No tax for years 1 – 13
2013 rates thereafter
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Long-Term Trust Model I
 $5.12 Million Trust Subject to Fiduciary Income Taxes
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Long-Term Trust Model I
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Long-Term Trust Model I
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Long-Term Trust Model I
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LONG TERM TRUST DESIGN
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Long-Term Trust Model I
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LONG TERM TRUST DESIGN
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Long-Term Trust Model I
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LONG TERM TRUST DESIGN
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Long-Term Trust Model I
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Long-Term Trust Model I
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LONG TERM TRUST DESIGN
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Long-Term Trust Model II
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$5.12 Million Trust with Grantor Trust Status until 2026
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Long-Term Trust Model II
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Long-Term Trust Model II
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Long-Term Trust Model II
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LONG TERM TRUST DESIGN
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Long-Term Trust Model II
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LONG TERM TRUST DESIGN
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Long-Term Trust Model II
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LONG TERM TRUST DESIGN
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Long-Term Trust Model II
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Long-Term Trust Model II
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Long-Term Trust Model II
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Financial Modeling: Implications for Estate
Planning & Trust Design
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 Role and Design of Financial Models
 Trust Design Issues
 Trust Design
 Breadth of Beneficial Interests
 Differentiation of Discretionary Standards
 Trust Termination
 Asset Allocation/Asset Selection
 Family Expectations
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Planning for Unique Assets
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Long Term Planning for Unique Trust Assets
 Recurring Fiduciary Challenges
 Control
and Management: Fiduciary Responsibility
 Liquidity,
Cash Flow & Expenses
 Retention
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and the Duty of Diversification
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Fiduciary Responsibility
 Conventional Trusts v. Directed (Administrative) Trusts
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Long Term Planning for Unique Trust Assets
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Fiduciary Responsibility – Conventional Trust
TRUSTEE(s)
Specialized
Asset
Management
Tax Planning
and
Compliance
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Long Term Planning for Unique Trust Assets
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Beneficiary
Communications
Custody
and
Reporting
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Fiduciary Responsibility – Directed Trust
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Beneficiary
Communications
Discretionary
Administration
Tax Planning
and
Compliance
General
Asset
Management
Administrative
Trustee
Investment
Advisor
Specialized
Asset
Management
Custody
and
Reporting
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Changes In Trust Design – Enterprise Trust
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Beneficiary
Communication,
Custody, Reporting,
Oversight
Discretionary
Administration
Admin
Trustee
Disc.
Committee
Special
Asset
Management
Special
Assets
Advisor
Values
Mission
Goals
Investment
Advisor
Tax Advisor
Trust
Protector
Trust Modification
Fiduciary Removal
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Tax Planning
& Compliance
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Fiduciary Responsibility
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 Delaware Administrative Trust (12 Del. C.§3313(b) & (e))
 The
directed trustee under a Delaware administrative trust has no duty to:
 Monitor the advisor’s conduct;
 Provide advice to or consult with the advisor;
 Warn or apprise beneficiaries about the advisor’s directions
 The
directed trustee, under the Delaware statute, following an advisor’s direction is
liable for losses only for the trustee’s own “willful misconduct.”
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Fiduciary Responsibility
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 Directed Trusts Under the Uniform Trust Code or the Common Law
 Settlors
may allocate trust functions among the primary trustee and advisors as
they provide in the trust document (UTC §808).
 The
primary trustee’s standard for review of the advisor’s actions will depend on
local law or the trust terms.
 Uniform Trust Code: the trustee must act as directed unless advisor’s action is:
– Manifestly contrary to trust terms
– A serious breach of fiduciary duty
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Fiduciary Responsibility
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 Drafting to Allocate Responsibility to an Advisor
 Define
the scope and terms of the advisor’s responsibility;
 Set
the standard of review to which the advisor’s actions will be subjected by the
primary trustee.
 Specify
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whether the advisor’s power is fiduciary or personal in nature.
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Northern Trust Revocable Trust Form - 201
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If non-marketable assets (e.g., partnership interests, closely held stock, real estate, loans) or investment
concentrations of marketable securities may be included in a trust, this should be discussed in advance with
the corporate trustee. If these assets are to be retained, clients usually want to relieve the corporate trustee of
investment responsibility for them. If this is desired, add to the end of SEVENTH:
SECTION 20: A Trust under this agreement may hold some or all of the following assets, which shall be known as
“special assets:”
_____________________________________________________________
_____________________________________________________________
_____________________________________________________________
Notwithstanding the general investment powers of the trustee, the following provisions shall apply to the special assets in
the trust:
a) I appoint the following individuals who are willing and able to act (singly, and in the order listed) to act as manager
for the special assets in the trust:
Myself
ii.
The remaining individual cotrustees or cotrustee of the trust (if any)
iii. _____________________________________________________
iv. _____________________________________________________
While a manager is acting, the manager shall have sole investment, voting and management responsibility (and
the trustee shall have no such responsibility) for the special assets in the trust. The trustee shall sell the special
assets, and deal with them, only upon the written direction of the manager. The trustee shall be under no
obligation to review the special assets, make any investment recommendation with respect to them, solicit any
direction from the manager, or value special assets which are non-marketable. The trustee need not review
whether the manager is satisfying his or her responsibilities hereunder, and the trustee shall not be liable for any
action or inaction of the manager.
i.
b)
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Northern Trust Revocable Trust Form - 201
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c)
The powers of the manager (other than myself) shall be deemed to be and exercised as fiduciary
powers. Special assets may include stock or other interests in a corporation, partnership, limited liability
company or other entity (herein called a “company”). The manager’s fiduciary powers shall not preclude
the manager from holding office in a company, accepting remuneration from it, voting any interest in
favor of himself or herself as director, manager or officer, or purchasing or selling interests in the
company. The trustee shall make tax elections with respect to a company only as the manager directs.
If a firm succeeds to part or all of the business or assets of a company by merger, consolidation,
reorganization or otherwise, the trust’s interest in that firm (whether or not publicly traded) shall continue
to be a special asset of the trust.
d)
Special assets may include interests in real estate. The trustee shall have no responsibility, other than
title-holding, for those interests and the tangible personal property associated with them. The manager
shall have sole responsibility for managing, insuring, leasing and repairing the properties, collecting
rents, and paying all taxes and expenses on the properties. The trustee shall deal with the properties
only as and when directed to do so by the manager. If the manager asks the trustee to provide
additional money for the expenses or improvement of a special asset, however, the trustee shall have
responsibility for determining whether or not to provide funds. The manager may employ property
managers at the expense of the trust or may manage the properties personally. The trustee need no
review or inspect the properties, except that the trustee shall have the right (but not the duty) to exercise
the trustee’s environmental powers under this agreement.
e)
A manager shall be entitled to reasonable compensation, unless waived, and to reimbursement for
reasonable expenses, include travel costs.
f)
The statement of the trustee that it is acting according to this section shall fully protect all persons
dealing with the trustee. The trustee shall have no responsibility for any loss that may result from acting
in accordance with this section.
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Liquidity Issues
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 Trust Assets Presenting Liquidity/Cash Flow Issues
 Real
Estate
 Non
Marketable Entities
 Tangible
Personalty and Collections
 Intellectual
Property
 Consider Endowing “Income Consuming” Assets to Facilitate
Administration and Management
 Non-Income Producing Held in GST Exempt Trusts Present the Risk
of Tainting
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Statutory and Judicial Pronouncements on
Diversification
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 Uniform Prudent Investor Act, Section 3. Diversification
A trustee shall diversify the investments of the trust unless the trustee reasonably
determines that, because of special circumstances, the purposes of the trust are better
served without diversifying.
 Restatement Third, Trusts §91F
Whether and to what extent a specific investment authorization may affect the normal duty
to diversify the trust portfolio (see §90, Comment g) can be a difficult question of
interpretation. Because permissive provisions do not abrogate the trustee’s duty to
act prudently and because diversification is fundamental to prudent risk
management, trust provisions are strictly construed against dispensing with that
requirement altogether. Nevertheless, a relaxation in the degree of diversification may be
justified under such an authorization by special opportunities for the trust or by special
objectives of the settlor.
 Wood v. U. S. Bank, N.A. 160 Ohio App 3d 831, 2005
A trustee’s duty to diversify may be expanded, restricted, eliminated, or otherwise altered
by the terms of the trust. But this statement is true only if the instrument creating the trust
clearly indicates an intention to abrogate the common law, now statutory, duty to diversity.
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Concerns About Diversification
 Adverse Income Tax Consequences
 Unfamiliarity with Other Asset Classes
 Loss of Control
 Performance Expectations
 Impact on Portfolio Yield
 Legacy Holdings
 Fees
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Reasons for Non-Diversification
 Purpose of Trust
 Legacy Holdings
 Termination Date of Trust
 Interests
of Beneficiaries
 Step-Up
in Basis
 Illiquidity
 Loss of Controlling Interest
 Related Trusts
 Beneficiaries’ Assets
 Adverse Income Tax Consequences
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Grantor Intent – Trust Terms on Retention
 Silent Document
 Retention of Assets Acquired from Grantor is Permissible
 Retention of a Particular Asset is Permissible
 Retention of a Particular Asset is Preferred
 Retention of a Particular Asset is Mandatory
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Retention Language
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 Identify the Asset
 Explicitly Waive the Duty to Diversify
 Articulate the Reasons for Retention
 Address Asset “Conversion” Issues
 Equities:
 Real
Mergers, Acquisitions, Spin-offs
Estate: Sale, Reinvestment
 Consider Modifying the Fiduciary’s Standard of Care
 Conventional
 Directed
Trusts
Trusts
 Endow Operating/Holding Costs for Non-Income Producing Assets
 Provide a Means for Dispute Resolution
 Protect the Fiduciary
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Asset Concentrations: Risk Management Process
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I.
Policy
Follow trust terms or state Prudent Investor Rule
II.
Process
The trustee must have a process for identifying and evaluating concentrations
III.
Review
Determine grantor intent and fiduciary responsibility
IV.
Evaluation
Evaluate retention and diversification strategies
V.
Consultation
Consult with beneficiaries, their counsel, and trustee’s counsel
VI.
Implementation
Implement appropriate strategies
VII.
Documentation
Memorialize the process
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Unique Trust Assets - Examples
Bolivian Tin Mine
Bombay Cement Factory
Sewage Plant
Bingo Parlor
Las Vegas Casino
Hemp Factory
Methadone Clinic
Nudist Colony
Indonesian Brothel
Motel with Hourly Rates
Las Vegas Wedding Chapel
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Emu Farm
Llama Farm
Race Horse
½ Race Horse
Animal Reproductive Material
Animal Hospital
Pet Cemetery
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Statements of Intent
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Statements of Intent
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 Repeal of the Rule Against Perpetuities and the Proliferation of
Dynasty Trusts
 R.A.P.
has been repealed, extended, or optioned in 29 states and the District of
Columbia.
 The
continuing transfer tax window permits individuals to make substantial nontaxable gifts to long term, GST-Exempt dynasty trusts.
 Threats
to Dynasty Trusts
 Limits on leveraged estate planning techniques
 Discontinuation of grantor trust treatment
 Limitations on length of the GST exemption
 Reinstitution of the Rule/restoring the power of alienation
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Statements of Intent
 Dead Hand Control v. Beneficiary Rights
 Tension
Between Settlor Control, Flexibility, and Future Interests
 Material
Purposes and the Claflin Doctrine
 Claflin v. Claflin
 Restatement (Third) of Trusts
 Uniform Trust Code
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STATEMENTS
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Statements of Intent
 Settlor Intent…Into Perpetuity
 Establishing
 Vagaries
and Adapting Settlor intent
of the Future
 Economic cycles
 Capital markets and investment practices
 Tax law
 Trust law
 Lifetime expenses (education, health care)
 Demographics changes
 Equitable
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Deviation Doctrine
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Demographic Changes
 Reproductive
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Variables
Conception
Husband
His sperm
Donor sperm
In Utero
Ex Utero
Inter Vivos
Posthumous
Her egg
Donor egg
Pregnancy
Wife’s womb
Surrogate’s womb
 Blended
Families
 Composition
 Generational Overlap
 Expansion

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of Marriage and Definition of Spouse
Increased Life Expectancies
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Wife
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Statements of Intent
 Instructions to the Trustee (and Other Fiduciaries)
 Letters
of Wishes
 Precatory
Language
 Statements
of Intent
 Demonstrates unique grantor intent
 Ties that intent to the trust (material purpose)
 Expresses grantor’s view on modification and termination
 Public
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Policy Limitations
STATEMENTS
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Statements of Intent
 Communications to Beneficiaries
 Wills
and Trusts as a Form of Personal Communication
 Ethical
Wills
 Family
Mission Statements
 Statements
of Intent
 Formulation
 Inductive Method
 Deductive Method
 Examples
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STATEMENTS
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