Legacy Trust

My brother and his wife recently set up something called a Legacy Trust. They looked at many different options, and decided on this one as a means to leave their estate to their children. He really could not explain the benefits to me, but I know we have many of the same goals: providing financial security for my children and grand children without exposing the assets in the trust to predators (divorcing spouses and the like). I can make yearly contributions, but want to make sure I have as much protection from estate taxes as possible. Is this for me?

The term "legacy trust" is really sort of a "brand name" for the generation-skipping trusts that have been around for a long time. They are very similar to dynasty trusts with the terms being used interchangeably. Please read our article on Dynasty Trusts in conjunction with this one as their is information in that article that also applies to legacy trusts (i.e. Generation Skipping Tax Exemption).

Wealthy families, like the DuPont’s and Rockefellers, used this type of trust to preserve wealth for generations to come. The purpose of a legacy trust is to allow assets to remain in a trust to be used to support multiple generations without being depleted by by having to pay transfer (gift and/or estate) taxes each time the trust passes to a new generation. The tax savings can be significant because, as discussed at estate tax, estate taxes are quite high if you have to pay them. Once you add in any state transfer taxes, you can easily lose more than half the value of your assets to taxes each time they are transferred to a new generation. This is what happens with a normal will or trust. Also, this issue of estate taxes will increase in 2011 when the estate tax exemption is scheduled to revert to only $1 million.

The legacy trust avoids those transfer taxes on each generation -- to a point. So, multiple generations can benefit from the trust without multiple payments of estate or gift taxes. Legacy trusts are sometimes referred to as a Wealth Trust or even as a dynasty trust. They are usually all talking about the same thing. It is a third-party trust that creates a separate entity – a second protected estate. As a second estate, it removes assets from your estate (outside of the reach of creditors, divorcing spouses, judgments, and other nasty things.) It provides great protection against predators – something you mentioned as a primary concern.

It is also important to be able to fund this type of trust properly. Traditionally a Legacy Trust is funded through annual gifts. Think of it as a family savings plan. It creates a new, tax-free estate through these annual contributions that reduces your family’s estate tax bill dramatically. It is often used to supplement or replace pension and IRA assets that are exposed to tax risk.

A Legacy Trust provides for a family long after the maker has passed away. The Legacy Trust can be subdivided into separate trusts when the creator(s) die. Each beneficiary could become his or her own trustee. If the beneficiary is too immature to act as a trustee, then it is advisable to consider another trustee. This can also allow for greater protection from creditors, tax advantages, etc. It remains in force throughout the lifetime of the youngest beneficiary alive on the date the trust becomes irrevocable -- plus 21 years. This avoids running afoul of the Rule against Perpetuities which might invalidate the trust. The trust can continue for generations (as long as one has heirs) and provides for grandchildren, great-grandchildren, and beyond.

Often a Legacy Trust can provide for a family from 80 to 100 years. For instance, imagine you make the trust irrevocable when you have a 2 year old grandchild. That grandchild is potential heir which means that for his or her life, plus 21 years, the trust can continue supporting generation after generation without further transfer taxes. Many states (22 at last count) have abolished the Rule Against Perpetuities and many of them have even more flexible rules allowing the trust to continue even much longer (sometimes perpetually) without transfer taxes.

This trust can take full advantage of the maker's lifetime estate and gift tax credits and the annual $13,000 (as of 2011) gift tax exclusion. Another benefit is that judicial proceedings for Legacy Trusts may be sealed to provide privacy.

The Legacy Trust allows the maker to pass on gifts to his or her family. It can also provide steady income that can pay for many types of expenses. The trustee who controls the trust can pay for college education, provide income to children or grandchildren, or meet emergency needs (sometimes even yours) in case of hardship.

The Legacy Trust is a very effective way of reducing estate taxes. It insures money transferred from one generation to the next is not taxed each time it transfers. Through the Legacy Trust, every dollar can pass through, and potentially support, approximately three generations (lives in being at time of trust plus 21 years) without estate taxes.

Just remember: there are risks with this and any kind of gift-giving program as you are legally, and potentially irrevocably, transferring your wealth. Carefully evaluate gift giving, even when your goal is to reduce eventual estate taxes. You must be certain you can afford to give away your property during your lifetime.

This is not a do-it-yourself project. You need the help and counsel of an living trust attorney who can insure things are done properly.

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