Using Dynasty Trusts to Benefit the Client, Not Just the Client's Beneficiaries
by Briar K. Stahl

Most estate planners today attempt to help alleviate the transfer taxes owed by wealthy families through various wealth shifting techniques to the children and future generations. Most commonly, a client will set up a dynasty trust for the benefit of his children and descendants and sometimes his spouse. The trust will be an irrevocable dynasty trust structured to last for as long as state law will allow through the use of generation skipping provisions. The client will then shift his assets (by gift or sale) into this trust for the benefit of the beneficiaries. However, since the client is the grantor of the trust, he cannot be a beneficiary and will therefore lose access to the assets shifted into this trust. While this type of planning can be very effective to protect wealth for the client’s beneficiaries, this planning does not have a direct financial benefit for the client. This article proposes that through the use of a properly structured dynasty trust, clients can continue to benefit from the use and enjoyment of their own assets while protecting them from virtually all creditors and the transfer tax system.

Locating a grantor of the dynasty trust
The first step in forming this kind of dynasty trust is locating a person willing to set up the dynasty trust for the benefit of the client. Technically, the grantor of the trust can be anyone other than the client, however, the author recommends locating a person who would naturally be inclined to benefit the client, such as a parent or a grandparent. Also, the grantor must be capable and willing to gift a certain amount of money into the trust for the benefit of the client. Having a person other than the client form the dynasty trust allows the client to be a beneficiary of the trust and benefit from the assets owned by the trust.

Structuring the dynasty trust
The dynasty trust shall be structured as an irrevocable trust, with the client’s parent or grandparent (or some other person) as the grantor. The client will either be the sole Trustee or will be a co-trustee with powers to make investment decisions. The client will be the initial “primary” beneficiary and the client’s spouse and children or more remote descendants may also be initial permissible distributees. The language permitting distributions to the beneficiaries will either be fully discretionary or will be limited to an ascertainable standard such as “health, education, maintenance and support” (HEMS). Trusts limited to an ascertainable standard are typically called “support trusts.” If the distribution language is limited to an ascertainable standard, the client may be the sole trustee and may make all financial and distribution decisions over the trust. This trust drafting philosophy may be very attractive to many clients because of the elements of control the client will have over the trust. If the trust is not limited to an ascertainable standard, but instead allows distributions for any reason (fully discretionary trust), someone other than a beneficiary or potential beneficiary must be appointed as the trustee or as a co-trustee with the power to make distribution decisions. For tax purposes, this “distribution trustee” is often limited to anyone other than a related party or a subordinate employee. IRC §672(c).

Enhanced creditor protection of a fully discretionary dynasty trust
At first glance, a fully discretionary trust requiring the role of a distribution trustee may not be as attractive to clients as a trust that is limited to an ascertainable standard where the client can be the sole Trustee. However, there is an extremely important difference regarding the levels of creditor protection that each kind of dynasty trust offers. While both support trusts and fully discretionary trusts protect the assets of the trusts from nearly all creditors, there are a few exception creditors than can pierce through a support trust, whereas assets held in a fully discretionary trust with the distribution power held by the distribution trustee, are protected from virtually all creditors. The main exception creditor of a support trust is a divorcing spouse. In re Threewitt, 20.B.R. 434 (Bkrtcy. D. Kan. 1982). Since the divorce rate today is well over fifty percent, and since the dynasty trust is drafted to last for generation after generation where there will inevitably be numerous divorces amongst the beneficiaries, all estate planners should be counseling their clients on the creditor protection benefits of using a fully discretionary dynasty trust with distributions in the hands of an independent distribution trustee.

Keeping control in the hands of the beneficiary/client
If the client’s primary estate planning goal is to protect his hard–earned wealth from the transfer tax system and from all creditors, including divorcing spouses, then a discretionary trust is by far the best option. However, this option will only be attractive to the client if he will remain in control of the assets of the trust. The elements of control that can be placed in the hands of the client in his capacity as both the beneficiary and the “investment trustee” will give him virtual control over the assets of the trust similar to holding the assets free of trust.

First, the client will have the power to remove and replace the trustees for any reason. Priv. Ltr. Rul. 97-46-007 (Aug. 11, 1997). While placing the distribution decision in the hands of a distribution trustee seems to take away control from the beneficiary, if he has the power to remove and replace the distribution trustee, he still remains in full control. If the distribution trustee is ever uncooperative, the client can simply remove the distribution trustee and appoint a new distribution trustee.

Second, if the client/beneficiary holds the role of investment trustee, he will be in charge of all investment decisions of the trust assets. The “Trustee Powers” section that typically appears in all dynasty trusts can be drafted to give the investment trustee the power to invest the trust assets any way that he pleases. Specifically, the author recommends drafting the trust such that it opts out of the “Prudent Person Rule” to give the investment trustee full investment power over the trust assets. Therefore, the client, in his capacity as the investment trustee can use and invest the assets of the trust in a fashion that is equivalent to outright ownership of the trust assets.

Lastly, the client in his capacity as the beneficiary of the trust can be given a very broad special testamentary power of appointment over the trust assets. A special testamentary power of appointment is the power to change how the assets are to pass after the client’s death. The power of appointment can be so broad as to allow the client to appoint the assets of the trust to anyone other than himself, his estate, his creditors or the creditors of his estate. IRC §2041(b)(1). By the beneficiary holding this broad special testamentary power of appointment, the terms of the trust are not locked, but can be continually changed just as if the client owned the assets free of trust.

Using the dynasty trust most effectively
Once the dynasty trust is formed and funded, the client can use the trust in various ways. The dynasty trust can be structured as income taxable to the client as the beneficiary of the trust. This is done by giving the client/beneficiary a crummey power of withdrawal over the entire amount of all gifts to the trust. IRC §678(a)(1). If the income generated by the trust is taxable to the beneficiary, the beneficiary may interact with the trust on an income tax-free basis. Rev. Rul. 85-13. One of the ways the client may interact with the trust is to sell discountable assets into the trust in exchange for a promissory note. Discountable assets are those where the sum of divided partial interests are valued less than the undivided asset as a whole. Discounts are typically given for lack of marketability and lack of control. By selling discounted assets into the trust, the client has reduced his estate for estate tax purposes and protected the shifted assets from virtually all creditors, yet still maintains control over the assets. In addition, the client may still benefit from the assets in the trust at the discretion of the trustee.

The client can also use this dynasty trust as a powerful investment tool by investing in assets likely to appreciate or in a new business venture inside the trust, rather than in his own estate. The wealth generated by the investments would be inside the dynasty trust, protected from creditors and the transfer tax system. By simply having a person other than the client set up a dynasty trust for the benefit of the client, his spouse and descendants, instead of having the client set up the trust for the benefit of his spouse and descendants, estate planners can help a wealthy client achieve his wealth-shifting and asset protection goals while allowing him to continue benefiting from his hard-earned wealth.

Briar K. Stahl is an attorney with the law firm of Holland & Hart LLP as part of the Private Client Group in the Las Vegas office. She practices primarily in the areas of estate planning, business planning and asset protection. For more information, please contact the author at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it .

Drafting a Trust for Maximum Creditor and Divorce Protection
by Steven J. Oshins and Catherine M. Colombo 

An irrevocable trust set up by someone other than one of the beneficiaries provides the ultimate in creditor protection. With a divorce rate of over fifty percent, as well as an increasing number of lawsuits, creditor protection is often the most important objective of our clients. Historically, the general rule has been that the creator of the trust can dictate who may receive the beneficial enjoyment of the property and the extent and circumstances under which this enjoyment may be obtained. As a result, unless trust property is distributed outright to a beneficiary, it will generally be protected from the beneficiary’s creditors.

The general rule is that through accepted legal remedies, a creditor of a debtor stands in the shoes of the debtor and may exercise any property or other right that the debtor may exercise. So does this mean that a creditor may attach a beneficiary’s trust interest or force the trustee to make a distribution to the creditor in satisfaction of a beneficiary’s debt? If this is the general rule, does an estranged spouse have more rights to attach a beneficial interest under domestic relations law than an ordinary creditor? Does a discretionary trust provide stronger creditor protection than a support trust? This article will answer these questions.

For mature, competent family members who would receive the property outright, were it not for the benefits that can be derived through the receipt of property in a trust, the trust should be designed to give the beneficiary of a trust the functional equivalent of outright ownership, including undisturbed control over the property. Indeed, many candidates for this type of planning would be unwilling to create such a structure unless the trust benefits are coupled with the ability of the beneficiary to obtain control over the trust property that is virtually tantamount to outright ownership.

A surprisingly large number of wealthy estate owners and persons who are otherwise astute in business and finance neither recognize the wealth planning and creditor protection opportunities available to them, nor realize the potential diminution of family assets that can be unnecessarily and irretrievably lost through exposure to both the wealth transfer system and the failure to use creditor protection strategies. A properly structured irrevocable trust can avoid this exposure.

Staggered distribution trusts
Staggered distribution trusts should never be used. A “staggered distribution trust” is a trust which makes mandatory distributions to the beneficiaries at staggered ages. For example, the trust may distribute one-third of the trust assets to the beneficiary upon reaching age 25, one-half of the balance upon reaching age 30 and the balance upon reaching age 35.

This distribution philosophy does not consider that many of our clients’ beneficiaries will have taxable estates and many, if not most, will either be sued or go through at least one divorce. Forcing the assets out of the trust because of a deficient trust-drafting philosophy exposes the assets to estate taxes, creditors and divorcing spouses. Perhaps the primary reason that these types of trusts are so widely used is because the formbooks are generally insufficient.

Dynasty trusts
In order to achieve the maximum transfer tax savings, the trust should be wholly exempt from the generation-skipping transfer tax. This will avoid the imposition of transfer taxes for successive generations. The trust should be drafted as a dynasty trust which is an irrevocable trust that is protected from estate taxes for as long as applicable state law allows. Effective October 1, 2005, Nevada law allows a dynasty trust to continue for up to 365 years. With proper drafting, a Nevada dynasty trust can also be designed to protect the trust assets from the creditors and divorcing spouses of the trust beneficiaries for up to 365 years.

Support trusts vs. discretionary trusts
Trusts are generally drafted as either: (1) mandatory distribution trusts, (2) support trusts, or (3) discretionary trusts. 

A “mandatory distribution trust” is a trust which requires the trustee to make distributions mandated by the terms of the trust agreement. The trustee may not withhold or accumulate a mandatory distribution. Unless there is a tax reason to do so, this makes some or all of the trust assets available to the beneficiary’s creditors and divorcing spouses for no reason but that the trust scrivener was using a trust “form” which was inadequate for planning purposes.

A “support trust” is created by the grantor to support one or more beneficiaries. A support trust directs the trustee to apply the trust’s income and/or principal as is necessary for the support of a beneficiary. The beneficiary of a support trust can compel the trustee to make a distribution of trust income or principal merely by demonstrating that the money is necessary for the beneficiary’s support, maintenance, education, or welfare, or whatever other standard is contained in the trust. The standard for distributions often contains words such as “health, education, maintenance and support” since that language keeps the trust assets outside of the trustee/beneficiary’s estate even though that person is both a beneficiary and is the sole trustee.

A “discretionary trust” allows the trustee complete and uncontrolled discretion to make allocations of income or principal if and when the trustee deems appropriate. Because the trustee is given such broad powers, the beneficiary can only compel the trustee to distribute funds if it can be shown that the trustee is abusing its discretion by failing to act, acting dishonestly, or acting with an improper purpose in regard to the motive in denying the beneficiary the funds sought. A discretionary trust generally uses permissive language such as the word “may” instead of the word “shall.” The permissive word “may” is still generally further qualified by granting the trustee unfettered discretion using words such as “sole and absolute discretion,” “absolute and uncontrolled discretion” or “unfettered discretion.”

Beneficiary controlled discretionary trusts
Since the terms of a discretionary trust exceed the ascertainable standard permitted by Section 2041 of the Internal Revenue Code, a beneficiary cannot serve as distribution trustee without causing the trust assets to be included in that beneficiary’s estate for estate tax purposes. Therefore, in order to draft the trust as a Beneficiary Controlled Discretionary Trust, the trusteeship should be bifurcated into two separate roles. Upon reaching a selected age, the beneficiary becomes the investment trustee and has the power to fire and hire trustees. The other trustee, often the beneficiary’s closest friend, acts as the distribution trustee since the beneficiary cannot have that power.

Spendthrift provisions
A spendthrift provision is a provision in a trust agreement that provides that the beneficiary cannot sell, pledge or encumber his beneficial interest, and provides that a creditor cannot attach a beneficiary’s interest. At common law, the purpose of a spendthrift trust was to protect a beneficiary from his own spending habits. The idea was to provide for someone who could not provide for himself, and to keep such beneficiary from becoming dependent on public assistance. Therefore, if a spendthrift clause was added to a trust, the common law developed a legal principle that a creditor could not recover from the beneficiary’s interest.  

A beneficiary of a discretionary trust does not need to rely on a spendthrift provision because neither the current distribution interest nor any subsequent interest is a property interest under state law. Therefore, neither the beneficiary nor the creditors of the beneficiary have any right to force a distribution from the trust. However, as a matter of course, trust scriveners should nearly always include spendthrift provisions even when using a discretionary trust.

The rule is different for support trusts. The Restatement Second of the Book of Trusts, Section 157, carves out four key exceptions to spendthrift protection, where a creditor may attach the assets of a support trust. Those exception creditors are: (1) alimony or child support, (2) creditors for necessary services or supplies rendered to the beneficiary, such as medical services, (3) services rendered and materials furnished that preserve or benefit the beneficial interest in the trust and (4) a claim by the U.S. or a state to satisfy a claim against a beneficiary, such as a tax lien.

Applicable state law will determine which exceptions, if any, apply. Nevada law is very protective for support trusts. However, our clients’ descendants often live in other states, so unless the trust is drafted to continue with at least one Nevada trustee at all times in order to maintain Nevada jurisdiction, it is generally prudent to draft trusts for Nevada residents as discretionary trusts.

Conclusion
It is generally insufficient to draft a trust with mandatory staggered distributions for the beneficiaries upon reaching certain ages. Rather, the trust should be drafted to continue in trust for the beneficiary. For those beneficiaries who are financially astute, the trust should be drafted to give the beneficiary control as trustee. For maximum creditor and divorce protection, the trust should be designed as a discretionary trust rather than a mandatory distribution or support trust.

Steven J. Oshins and Catherine M. Colombo are attorneys at the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. Their practice is focused on estate planning and asset protection for high net worth individuals. Steve is the author of Nevada’s 365-year dynasty trust law.