21st Century State-of-the-Art Dynastic Estate Planning with an Emphasis on Multiple Generations
Steve Driscoll, Esq., Driscoll Anderson Reynard, LLP
and
Zach W. Hurst, CFP®, CLU®, Valmark Financial Group
In collaboration with
Terry R. O’Neill, Founder, Institute for the Study of Global Economics and Finance (ISGEF)
(Democratizing information and advancing the frontiers of economic thought…)
Most historians will tell you that the Battle of Waterloo was won by the Duke of Wellington when he defeated Napoleon; however, the real winner was Nathan Rothschild, a banker. The explanation - Rothschild had two observers on the battlefield who saw the Prussians come out of the forest and devastate Napoleon’s army. The observers rode on horseback to the Belgium coast, and they sent a message by carrier pigeon to Rothschild in England, informing him that Napoleon had been defeated. Now everyone knew that Rothschild had the information edge; so, when he went short in the stock market the next day, everyone followed his lead. Just before the market closed that evening, however, Rothschild switched to a long position. Then he went to sleep, and, according to some sources, awoke the next morning as the richest man in the world.
The key to Rothschild’s success was his information edge. To give you the information edge on a topic of great relevance to our profession: preserving wealth for your clients from one generation to another, we sat down with Zach W. Hurst, CFP, CLU, Valmark Financial Group, Terry R. O’Neill Founder of the Institute for the Study of Global Economics and Finance and Steve Driscoll, Attorney at law, Driscoll Anderson Raynard to discuss the benefits of estate planning -- specifically dynastic planning. Zach W. Hurst and Terry R. O’Neill recently authored: “Democratizing Retirement Income Planning Through the Lens of Economics and Finance: The De-Accumulation and Stewardship of Assets.” This is the second of three installments devoted to retirement planning.
Caveat: While your estate may not be near the amounts discussed, we are communicating concepts. And, you may not need these trusts but we want to take on a broader perspective and we hope you gain some insight. For the purpose of these concepts, we are using the specific example of a husband and wife with two children, where the wife is the surviving spouse, noting that there are a multitude of familial configurations to be considered as you plan.
Preserving Wealth for Multiple Generations
Basic estate planning involves taking your assets and designing a way for them to pass to your children and your loved ones in the most efficient way possible, while navigating both the tax and non-tax ramifications. Together, we will outline for you some cogent concepts in estate planning—concepts that can not only preserve your assets after you have died, but that could dramatically increase the wealth your children (and your grandchildren) will receive. Using these techniques, you can arrange your assets to be outside of the transfer tax system for potentially the next 80 to 125 years.
It’s important that you do the necessary estate planning in advance. This means now, while you’re still alive and well. Careful estate planning preserves the value of your estate, and ensures that your heirs receive the largest possible transfer of wealth. And, by the way, did you know that life insurance can be the cornerstone of intelligent estate planning?
The “No Estate Planning” Plan
Let’s take the example of a married couple with two children, living in California (a community property state). When one spouse dies, even without formal estate planning, most of those assets are passed to the surviving spouse with no probate and no estate taxes. Sounds great, right? Not so fast. Here are four potential issues:
#1. The plan of “no estate planning” doesn’t deal with the event of incapacity (i.e., being unable to manage your own financial affairs or make your own personal decisions, possibly due to a physical or mental disorder). You have no recourse for incapacitation except for going to court.
#2. When the surviving spouse passes away, the probate court will take title to the assets and transfer them to the heirs. It can be an onerous process, lasting about a year to a year and a half. Probate court takes a fee that starts, generally, at 4% of gross assets.
#3. The assets go outright to your heirs. If you have minor children, the court will appoint a guardian for the minor’s inherited assets, which can be a costly process. The court will also require an accounting every two years. Once the beneficiary turns eighteen years of age, there is no one to oversee those assets—a child has complete access to them, which could potentially put your lifetime of carefully preserved assets at risk in a hurry.
#4. There could be significant estate tax costs when the second spouse passes away. Estate tax (which is paid when the second spouse passes away) is based on the value of assets that someone owns when they pass away. The federal estate tax rate currently sits at 40% but historically has been as high as 77%.
When someone dies, the federal government wants to know their net worth as of the day they died, and it assesses a tax based on the value of their property, known as federal estate tax. Some states also assess an inheritance tax of their own; this tax usually follows the federal estate tax rules and, to a certain extent, is deductible from the federal estate tax payable. The federal estate tax is part of the Internal Revenue Code and is a self-reporting tax, similar to income tax. If you were to die before your spouse, he or she may need to complete a federal estate tax return, Form 706, which reports your net worth as of the date of your death and computes the tax payable. It will be necessary for your spouse to obtain appraisals stating the value of all of your properties as of the date of your death. After all of these values have been obtained, they will be listed on form 706. Your spouse will be allowed to subtract debts, such as the balance on your mortgage, unpaid taxes, funeral expenses and last illness expenses not yet paid. Form 706 must be completed and filed within nine months after your death, and the tax that is due, if any, must be paid at that time in cash. This tax must be paid in full by the estate before any assets from it can be distributed to your heirs.
When the first spouse passes away, the estate passes to the surviving spouse tax free, no matter how large the estate, via the unlimited marital deduction - a provision given by Congress to allow married couples to make unlimited inter-spousal transfers of property without incurring tax, either during life or at death. When the second spouse dies, however, that’s when you have the potential for estate tax.
However, Uncle Sam added an interesting twist to all of this, and that’s an individual federal estate tax exemption. Everyone has an amount that can allow for some or all of the estate to pass tax free. Under current law today (2022), each individual has an exemption that allows $12,060,000 of assets to pass estate tax free, so a husband and wife have a combined credit of over $24 million. Currently, only the very wealthy pay estate tax at death (i.e., estate taxes would be due only on the value of their estate that exceeds the $24 million exemption). However, on January 1st, 2026, the estate tax exemption is dropping to approximately $6.5 million (depending on inflation between now and then). Beginning in 2026, a married couple will have a combined credit of $13 million (a big difference from a combined credit of over $24 million). So, more people’s estates will have the potential for estate tax, making this an important discussion to be having now!
Basic Estate Planning
Before we get back to transferring assets efficiently, let’s take a brief moment to mention some other estate planning documents to have in place prior to more advanced planning. For a typical couple working through their estate plan, consider the following four documents:
#1. A will - a legal document that allows you to name guardians for minor children. A will is also a document that can coordinate the distribution of your assets after death, by providing instructions of how and when the named beneficiaries will receive the assets. However, in more sophisticated estate plans, the latter function is controlled by the living trust described in #4 below.
#2. Advanced health care directive - a legal document used to direct loved ones and medical professionals when they need to make medical decisions on your behalf if you cannot make the decisions yourself.
#3. Durable power of attorney (DPOA) - a legal document that authorizes someone to act on your behalf that remains in effect if you become incapacitated. These powers include non-medical decisions such as managing financial assets, applying for government benefits, and filing tax returns.
#4. Living trust - a legal document that designates how to distribute your assets after you die. This trust owns the assets, while still allowing you to maintain control. Some additional benefits of a living trust will be discussed in the following paragraphs.
Your Main Document: The Living Trust
A living trust (or inter vivos revocable trust) is formed while you are still alive. However, as previously mentioned, the assets, property, etc. are titled in the name of the trust. It will then distribute said assets to people (or organizations) you select upon your passing, according to the terms established during your lifetime. There are 3 parties to the trust: trustor(s) (who transfers the assets to the trust), trustee(s) (who manages the assets for the beneficiaries according to the wishes of the trustor), and the beneficiaries. While living, a husband and a wife (for example) are the trustors, the trustees and the beneficiaries. As trustees, they would have access to all the assets in the trust at any time— access that would be permitted to no one else— just as if they had retained ownership of those assets themselves. They would also have the right to amend or revoke the trust at any time while they were both alive. When the husband and wife pass, they can name a successor trustee to make distributions of their assets to the beneficiaries, ruling out the necessity for probate court. Additional controls can be added to the terms of the trust to state more specially the timing of distributions (eg. ⅓ at 35, ⅓ at 45, ⅓ at 55).
The trust could also be the beneficiary of a life insurance policy, distributing the death benefit proceeds in line with the terms of the trust versus outright to an individual or entity. However, living trusts do not eliminate any federal estate tax, as the value of assets owned inside the living trust are includable in an individual’s taxable estate.
It all begins with an idea. Maybe you want to launch a business. Maybe you want to turn a hobby into something more. Or maybe you have a creative project to share with the world. Whatever it is, the way you tell your story online can make all the difference.
Don’t worry about sounding professional. Sound like you. There are over 1.5 billion websites out there, but your story is what’s going to separate this one from the rest. If you read the words back and don’t hear your own voice in your head, that’s a good sign you still have more work to do.
Be clear, be confident and don’t overthink it. The beauty of your story is that it’s going to continue to evolve and your site can evolve with it. Your goal should be to make it feel right for right now. Later will take care of itself. It always does.
Using Trusts To Reduce Estate Taxes
A simple living trust would continue to have all assets stay in one trust after the death of the first spouse. A second option is to have the provisions of the living trust state that the deceased spouse’s portion of the assets be moved into one, or possibly two, irrevocable trusts in order to provide protections for the deceased spouse’s assets. Having the deceased spouse’s assets go into an irrevocable trust means that the surviving spouse cannot change the provisions of the trust. However, the assets inside the irrevocable trust gain creditor protection and avoidance of being included in the estate of the surviving spouse. To discuss these irrevocable trusts created at the passing of the first spouse, let’s use an example. Meet Jack and Wendy Smith, who have worked extensively with their estate planning team to create a plan intended to preserve their accumulated wealth. This plan involves the formation of their living trust which, as we discussed earlier, shall, upon the death of the first spouse, be divided into a revocable (and amendable) survivor's trust, an irrevocable bypass trust (sometimes referred to as a credit shelter trust), and possibly an irrevocable QTIP trust (qualified terminable interest property trust).
Note from the authors: Just because a trust is labeled “irrevocable”, flexibility can be built in. While the original provisions cannot be changed, the trustor could give each generation the ability to change the terms, under a “limited power of appointment”.
At the passing of the first spouse - in this case, Jack - several things will take place. First, 50% of the value of their assets representing the survivors share, would remain in the revocable living trust. Often this trust is now referred to as the survivor’s trust, for obvious reasons. Of the remaining 50% (Jack’s representative share of the estate), an irrevocable bypass trust would be funded up to the maximum amount of Jack’s share of the assets that could be sheltered by the Jack’s current federal estate tax exemption. Lastly, per the terms of the living trust, any remaining share of Jack’s assets flow into the QTIP trust. Now, let’s work through why these irrevocable trusts could help alleviate future issues.
The Bypass Trust and the QTIP Trust ensures that Jack and Wendy’s children will inherit Jack’s share of the assets when both Jack and Wendy have died. Without these irrevocable trusts, if Wendy were to remarry and her new husband were to outlive her, potentially all of Jack’s assets could pass to Wendy’s new husband rather than to Wendy and Jack’s children. The Bypass Trust and the QTIP Trust enables Jack to earmark his share of the assets specifically for his wife and children. Wendy can use the assets in the Bypass Trust and the QTIP Trust as she pleases while she is alive; but once she dies, whatever remains in the trusts must go to the Smith’s children. The assets in the Bypass Trust and the QTIP Trust are also fully protected from claims by creditors.
To restate, for the rest of Wendy’s life, she has complete and sole access to all three trusts listed above. Furthermore, because all of Jack and Wendy’s property remains in one of three trusts created under their living trust, when Wendy dies there are no probate costs. At that time, Jack and Wendy’s children inherit the assets from all three trusts and can use those assets as directed by the terms of the living trust.
A QTIP trust does not eliminate any potential estate tax on assets funded into the trust. However, a QTIP trust does postpone any potential estate tax that may be due until the surviving spouse passes away because a properly drafted QTIP trust qualifies for the unlimited marital deduction. To qualify for the unlimited marital deduction certain provisions must be included in the QTIP trust. For example, the trust must provide that all income be payable at least annually to the surviving spouse— in this case, Wendy— and the principal may only be distributed to the surviving spouse. Similarly, if Wendy were to die first, a QTIP trust would earmark an equal amount of her assets for Jack and their children.
In contrast to a QTIP trust, the bypass trust can reduce, or possibly eliminate, estate tax. The assets of the Bypass will not be subject to estate tax when Wendy dies because the assets of the Bypass Trust are sheltered by Jack’s estate tax exemption. Prior to 2011 a married couple had to have the living trust to create a bypass trust on the death of the 1st spouse in order to not lose the deceased spouse's estate tax exemption.
In recent years, Congress has come up with ‘portability’ which refers to one spouse’s federal exemption amount transferring to the surviving spouse – so that the surviving spouse now has the combined total of both spouses’ exemptions. While transferring this exemption amount to your surviving spouse - forgoing the bypass trust - could still help alleviate the burden of future estate tax, it’s important to note that there is an additional benefit to creating a bypass trust.
To illustrate, if $6.5 million is placed in Jack’s bypass trust and Wendy survives him for another 15 years, the assets could hypothetically grow from $6.5 million to $10 million. When Wendy dies, these assets are still 100% sheltered from estate tax, not just the initial $6.5 million, but all the appreciation as well. Had we not placed the assets in trust, there would be estate tax above the exemption amount, even with portability. This makes maximizing the utilization of your estate exemption through the use of a bypass trust something to consider, especially when planning for multiple generations.
The following is a summary of the benefits of having a living trust place the decedent’s assets in a Bypass Trust and a QTIP Trust.
#1. In an irrevocable Bypass and QTIP trust, the decedent can have control over his or her assets when the survivor dies and is reassured in knowing that his or her assets will pass to his or her children. The survivor can’t change the decedent's wishes.
#2. An irrevocable Bypass and QTIP trust, gives the survivor asset protection. If the survivor was ever sued, those assets would be protected from lawsuits and creditors.
#3. In an irrevocable Bypass trust, the future appreciation on the decedent’s trust will escape estate taxation.
Generation Skipping Transfer Tax
So if irrevocable trusts can avoid potential estate taxes plus provide the added benefits of creditor, marital, and legal protection, why not continue passing assets in trust to the next generation, and the generation after that….forever? Well prior to current legislation, this was the case. Prominent families like the Rockefellers and the du Ponts did this type of planning all along. They never gave their assets to their children—they gave their assets to their children in trust. The children never owned the assets; so when they passed, they were not subject to estate tax a second time. What they didn’t spend stayed in the trust, and multiple generations were never subject to estate tax. In 1986, Congress acted, creating another exemption and tax mirroring the federal estate tax exemption called the generation skipping transfer tax (GSTT). This is an additional tax on the transfer of property that, per the name, skips a generation (i.e., grandparent to grandchild).
Without GSTT, for example, generation 1 (the grandparents) could pass assets directly to generation 3 (the grandchildren) that they would have otherwise inherited from generation 2 (the parents), avoiding the second round of estate taxes. GSTT closes that loop and essentially ensures that grandchildren end up with the same after tax value of assets that they would have had if the inheritance was given to them directly from their parents, rather than their grandparents. Cumulative gifts during life or bequests at death over the GSTT exemption are subject to tax similar to the estate tax exemption. However, you do not have the aforementioned portability of the GSTT exemption. If you don’t make the gifts during lifetime or create a bypass trust at death to utilize the GST exemption, it is gone forever! Bringing us back to one of the original themes of the article, “It’s important that you do the necessary estate planning in advance. This means now, while you’re still alive and well.”
So how could Jack and Wendy take advantage of both their federal estate tax exemption and their generation skipping exemption to efficiently pass on their accumulated assets to their children and grandchildren? Well, the 1986 Tax Reform Act also permitted the use of generation-skipping trusts, allowing individuals to utilize their GSTT exemption without having to bypass their children by having assets go directly to grandchildren. This concept is similar to the bypass trust, which utilizes a portion or all of the federal estate tax exemption. To continue our example, Jack and Wendy could arrange to have assets from their living trust placed in a separate multi-generational trusts (generation skipping trusts) at the death of the survivor of them, making use of the non-portable GSTT exemption. Each child’s trust would be split into two parts: (1) an exemption portion and (2) a non-exempt portion. Per the name, the exempt portion which is sheltered by Jack and Wendy’s GST exemption will be completely free of estate tax for multiple generations. Any non-exempt portion, plus any growth, will be subject to estate tax when the children die.
Under this arrangement, instead of receiving an outright inheritance after Jack’s and Wendy’s deaths, each child would be the trustee as well as the primary beneficiary of their own trust. Each, as trustee, would have the power to invest the assets in their own trust, as well as the responsibility to manage their trust intelligently, both for themselves and, ultimately, for their children. One result of this arrangement is that, for Jack and Wendy’s children, every investment and every transaction is easily accounted for, and every piece of property in either trust retains its separate character. If one of the children got divorced, the property in his or her trust would not be subject to divorce proceedings. Furthermore, creditors would not be able to make a claim against either trust. If they or any of their family members lose a lawsuit, their trusts would not be vulnerable to any lawsuit judgment. And when they pass away, the exempt portion of their trust will go to their children (i.e., Jack and Wendy’s grandchildren) 100% estate-tax-free. The nonexempt portion would also be passed on, of course, but it would be subject to estate tax.
We have now worked our way through the following concepts to keep in mind when crafting your own unique estate plan with a qualified team of professionals:
#1. Basic estate planning documents
#2. A living trust
#3. The benefits of irrevocable trusts for both the decedent and survivor(s)
#4. Utilization of your generation skipping exemption before it’s gone
To conclude, we would like to offer a final concept, which could not only help preserve your hard-fought-for wealth for the generations to come but enhance it.
Dynastic Planning with Life Insurance
A way to use your GSTT exemption is to make gifts during your lifetime. Reminder - you not only get the amount of that gift out of your estate but you also remove all of its future appreciation and future income from your estate. Therefore, the optimal assets to put in this trust are the ones that have the greatest potential for future growth, a similar concept to buying a stock at a low price and selling it at a high price. And as discussed in previous sections of this article, gifting to an irrevocable trust offers additional protection to consider. The asset type that can be owned by your trust, which has the potential (often guaranteed) for future appreciation, is life insurance - both existing policies or newly funded policies.
Scenario #1. Perhaps you have fully funded a life insurance policy with a $1 million death benefit. The value of the policy (for simplicity, we will use the cash value) is $100,000. This policy could then be placed in an irrevocable trust for future generations, shielded from estate tax. The leverage - although the policy will be worth $1 million at death, the gift amount which will reduce your exemptions is only the $100,000 current value!
Scenario #2. The leverage of life insurance is intriguing to you, and you would like to consider using a policy to provide for future generations. After selecting the right policy type and insurance carrier based on your individual health and cash flow, you set up an irrevocable life insurance trust (ILIT) to own a policy on your life. To keep the policy inforce, you make annual gifts to trust which in turn pays the premiums. Again, this could create significant leverage because only the annual gifts reduce your exemptions.
Note from the authors: After the completion a comprehensive economic analysis, the death benefit proceeds of a life insurance policy often become the most economic and tax-efficient methodology for paying estate taxes, even after implementing estate planning strategies. In addition, the aforementioned alleviates future generations from having to liquidate other inherited assets in suboptimal market conditions.
This graph provides a visual illustration of wealth passing in trust for multiple generations.
A Final Thought
Focusing on advanced estate planning is no longer for the very wealthy. Even families who know they won’t ever have estate tax or generation skipping transfer tax are still candidates for dynastic or multi-generational planning because of the aforementioned benefits. As you can see from the examples above, careful estate planning can make a major difference for your spouse, your kids, your grandchildren and/or your other heirs. But we strongly encourage, once again, that all estate planning be tailored to suit your own particular circumstances, needs and wishes— and it should be done only with the help of a competent estate planning team, which includes a life insurance advisor, accountant, and attorney. Good planning and Godspeed to each of you.
“Long range planning does not deal with future decisions but with the future of present decisions.”
- Peter Drucker
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This writing is a condensed version of the comprehensive chronology of multi-generational planning taken from “Using Life Insurance for State-of-the-Art Estate Planning,” Chapter 12, The Life Insurance Kit: The Truth about Life Insurance, Comprehensive Estate Planning in the 21st Century by Terry O’Neill, Dearborn Financial Publishing, Inc., 1993. The numbers have been updated to reflect current estate and gift tax law.
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Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation.
Note: This article was originally published in Technolink Association’s Good News in Action Magazine, September 11, 2022
ABOUT THE AUTHORS:
Steve Driscoll is a partner of the law firm of Driscoll Anderson Reynard, LLP. Steve practices exclusively in the area of estate and gift tax planning. Steve is a former CPA and holds a master’s degree in taxation. Steve was formerly a partner with the law firm of Hart, King & Coldren and formerly a Director with the national accounting firm of Deloitte, LLP where he served as Practice Leader for Estate, Gift and Trust Services for Southern California Arizona and Nevada. Steve also was an Assistant Professor at California Polytechnic University, Pomona, where he taught individual, corporate and partnership taxation and was the recipient of the 1986 Cal Poly Meritorious Performance and Professional Promise Award.
Zach W. Hurst is Director of Financial Planning at Valmark Financial Group where he oversees a team that assists independent financial advisors and wealth management firms with accumulation, income distribution, legacy planning, and product analysis. Zach is responsible for all aspects of design, marketing, and implementation of Valmark’s unique financial planning processes. Mr. Hurst is a presenter on financial planning topics at the University of Akron, where he graduated Summa Cum Laude. He is an A Certified Financial Planner ™ (CFP®), a Chartered Life Underwriter® (CLU®), and holds Ohio Life, Health, Accident and Variable licenses along with FINRA Series 7, 24 and 66 registrations.
Terry R. O’Neill founded his financial services enterprise in 1978, over four decades ago, specializing in the engineering of corporate employee benefit planning, executive benefit planning, and business succession planning for organizations. The enterprise designed comprehensive financial and wealth creation strategies, developed estate and retirement planning concepts along with multi-generational estate and wealth conservation strategies for families and individuals. He monetized the firm in 2017.
Over those four decades, Mr. O’Neill served on four major financial association boards: 3 domestic and 1 international. In addition, he was nominated to be an advisor to the Federal Open Market Committee, was an advisor to the Small Business Council of America, was an Associate Member of the Milken Institute and formerly a Member of Roubini Global Economics. Mr. O’Neill has advised two California Governors on economic and business issues. He has served on committees that have advised the U. S. Treasury and Congress on numerous financial topics.
He authored The Life Insurance Kit (1993: Dearborn Financial Publishing, Inc.), and has written for numerous publications in the financial industry including Financial Services Week, Employee Benefit Plan Review and The National Underwriter. Mr. O’Neill has appeared frequently as a guest on television and radio to discuss the economic ramifications of issues in healthcare, employee benefits and retirement planning and was profiled in Leadership Magazine and the Orange County Register. He has spoken regularly on economic and financial topics at national conferences.
Since 2017, Mr. O’Neill has been working exclusively on special economic and financial consulting projects. The majority of his time is devoted to the Institute for the Study of Global Economics and Finance which he founded in 2015. The Institute focuses on the democratization of global economic information and advancing the frontiers of economic thought.