1 EXPERIENCE THE RIGHT PARTNERSHIP Dynasty Trusts: Long Term Trust Design R. Hugh Magill Executive Vice President & Chief Fiduciary Officer © 2013 The.

1 EXPERIENCE THE RIGHT PARTNERSHIP Dynasty Trusts: Long Term Trust Design R. Hugh Magill Executive Vice President & Chief Fiduciary Officer © 2013 The Northern Trust Company - Rev. 10/2/2013 Community Foundation November 14, 2013

2 LONG TERM TRUST DESIGN Click here 2 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Todays Agenda: Long Term Trust Design Introduction Financial Sustainability Planning for Unique Assets Statements of Intent

3 LONG TERM TRUST DESIGN Click here 3 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Wealth Transfers After ATRA* 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. 201120122013 Exemptions$5,000,000 $5,120,000$5,250,000 Rate on Excess 35% 35% 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

4 LONG TERM TRUST DESIGN Click here 4 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Wealth Transfers After ATRA Rule Against Perpetuities Approximately 29 states have either repealed, optioned or extended the permissible period under the common law Rule Against Perpetuities (See Table A) making these states a logical choice for the situs of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 Administrations 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 Institutes 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).

5 LONG TERM TRUST DESIGN Click here 5 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. State Perpetuities Statutes RULE**STATES Permits Perpetual TrustsAlaska, 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 TrustsAlabama (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 USRAPAlabama, 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 Follows Common-Law RAPIowa, Mississippi, New York, Oklahoma, Texas, and Vermont Termination at Later of Death of Last Income Beneficiary or 20 years after Grantors Death Louisiana **January, 2013

6 EXPERIENCE THE RIGHT PARTNERSHIP Financial Sustainability

7 LONG TERM TRUST DESIGN Click here 7 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. 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

8 LONG TERM TRUST DESIGN Click here 8 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Financial Sustainability 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.

9 LONG TERM TRUST DESIGN Click here 9 A C C E S S. E X P E R T I S E. S E R V I C E. LONGTERM TRUST DESIGN 9 Family Tree Husband (70)Wife (70) Daughter (45) HusbandSon (40) Wife 2012 Grandson (15) Granddaughter (12)Granddaughter (10) Granddaughter (7) G-Granddaughter G-Grandson G-Grandson G-Granddaughter G-Granddaughter G-Grandson G-Grandson G-Granddaughter GGG Child GGG Child GGG Child GGG Child GGG Child GGG Child 2027 - 2038 2057- 2068

10 LONG TERM TRUST DESIGN Click here 10 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Modeling Assumptions Family Size – See Table Distribution Rates (Annual) Years1 – 100 Years10 – 121% 13 – 142% 15 - 173% 18 – 204% 21 – 265% 27 – 386% 39 – end7% Special Principal Distributions –$100,000 in each of years 15, 18, 20, 23 (inflation adjusted) Financial Sustainability

11 LONG TERM TRUST DESIGN Click here 11 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Financial Sustainability Capital Market Assumptions – See Models Tax Assumptions –Taxable Trust Ordinary Income 201235% 2013 to end43.4% Capital Gains 201215% 201323.8% –Defective Grantor Trust No tax for years 1 – 13 2013 rates thereafter

12 LONG TERM TRUST DESIGN Click here 12 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Long-Term Trust Model I $5.12 Million Trust Subject to Fiduciary Income Taxes

13 LONG TERM TRUST DESIGN Click here 13 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Long-Term Trust Model I

20 LONG TERM TRUST DESIGN Click here 20 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Long-Term Trust Model II $5.12 Million Trust with Grantor Trust Status until 2026

21 LONG TERM TRUST DESIGN Click here 21 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Long-Term Trust Model II

29 LONG TERM TRUST DESIGN Click here 29 LONG TERM TRUST DESIGN A C C E S S. E X P E R T I S E. S E R V I C E. Financial Modeling: Implications for Estate Planning & Trust Design 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

30 EXPERIENCE THE RIGHT PARTNERSHIP Planning for Unique Assets

Click here 31 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Long Term Planning for Unique Trust Assets Recurring Fiduciary Challenges Control and Management: Fiduciary Responsibility Liquidity, Cash Flow & Expenses Retention and the Duty of Diversification

Click here 32 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Fiduciary Responsibility Conventional Trusts v. Directed (Administrative) Trusts

Click here 33 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Fiduciary Responsibility – Conventional Trust General Asset Management Discretionary Administration Specialized Asset Management Beneficiary Communications Tax Planning and Compliance Custody and Reporting TRUSTEE(s)

Click here 34 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Fiduciary Responsibility – Directed Trust Discretionary Administration Beneficiary Communications General Asset Management Tax Planning and Compliance Specialized Asset Management Custody and Reporting Administrative Trustee Investment Advisor

Click here 35 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Changes In Trust Design – Enterprise Trust Values Mission Goals Discretionary Administration Beneficiary Communication, Custody, Reporting, Oversight Asset Managers Investment Consultant Special Asset Management Tax Planning & Compliance Trust Modification Fiduciary Removal Investment Advisor Tax Advisor Disc. Committee Special Assets Advisor Admin Trustee Trust Protector

Click here 36 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Fiduciary Responsibility Delaware Administrative Trust (12 Del. C.§3313(b) & (e)) The directed trustee under a Delaware administrative trust has no duty to: Monitor the advisors conduct; Provide advice to or consult with the advisor; Warn or apprise beneficiaries about the advisors directions The directed trustee, under the Delaware statute, following an advisors direction is liable for losses only for the trustees own willful misconduct.

Click here 37 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Fiduciary Responsibility 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 trustees standard for review of the advisors actions will depend on local law or the trust terms. Uniform Trust Code: the trustee must act as directed unless advisors action is: –Manifestly contrary to trust terms –A serious breach of fiduciary duty

Click here 38 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Fiduciary Responsibility Drafting to Allocate Responsibility to an Advisor Define the scope and terms of the advisors responsibility; Set the standard of review to which the advisors actions will be subjected by the primary trustee. Specify whether the advisors power is fiduciary or personal in nature.

Click here 39 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Northern Trust Revocable Trust Form - 201 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: i. Myself ii. The remaining individual cotrustees or cotrustee of the trust (if any) iii. _____________________________________________________ iv. _____________________________________________________ b) 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.

Click here 40 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Northern Trust Revocable Trust Form - 201 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 managers 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 trusts 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 trustees 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.

Click here 41 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Liquidity Issues 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

Click here 42 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Statutory and Judicial Pronouncements on Diversification 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 trustees 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 trustees 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.

Click here 43 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Concerns About Diversification Adverse Income Tax Consequences Unfamiliarity with Other Asset Classes Loss of Control Performance Expectations Impact on Portfolio Yield Legacy Holdings Fees

Click here 44 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. 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

Click here 45 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. 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

Click here 46 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Retention Language Identify the Asset Explicitly Waive the Duty to Diversify Articulate the Reasons for Retention Address Asset Conversion Issues Equities: Mergers, Acquisitions, Spin-offs Real Estate: Sale, Reinvestment Consider Modifying the Fiduciarys Standard of Care Conventional Trusts Directed Trusts Endow Operating/Holding Costs for Non-Income Producing Assets Provide a Means for Dispute Resolution Protect the Fiduciary

Click here 47 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Asset Concentrations: Risk Management Process 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 trustees counsel VI. Implementation Implement appropriate strategies VII. Documentation Memorialize the process

Click here 48 Long Term Planning for Unique Trust Assets A C C E S S. E X P E R T I S E. S E R V I C E. Unique Trust Assets - Examples Bolivian Tin MineEmu Farm Bombay Cement FactoryLlama Farm Sewage PlantRace Horse Bingo Parlor½ Race Horse Las Vegas CasinoAnimal Reproductive Material Animal Hospital Pet Cemetery Hemp Factory Methadone Clinic Nudist Colony Indonesian Brothel Motel with Hourly Rates Las Vegas Wedding Chapel

49 EXPERIENCE THE RIGHT PARTNERSHIP Statements of Intent

50 EXPERIENCE THE RIGHT PARTNERSHIP Click here 50 STATEMENTS OF INTENT A C C E S S. E X P E R T I S E. S E R V I C E. Statements of Intent 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 non- taxable 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

51 EXPERIENCE THE RIGHT PARTNERSHIP Click here 51 STATEMENTS OF INTENT A C C E S S. E X P E R T I S E. S E R V I C E. 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

52 EXPERIENCE THE RIGHT PARTNERSHIP Click here 52 STATEMENTS OF INTENT A C C E S S. E X P E R T I S E. S E R V I C E. Statements of Intent Settlor Intent…Into Perpetuity Establishing and Adapting Settlor intent Vagaries of the Future Economic cycles Capital markets and investment practices Tax law Trust law Lifetime expenses (education, health care) Demographics changes Equitable Deviation Doctrine

53 EXPERIENCE THE RIGHT PARTNERSHIP Click here 53 STATEMENTS OF INTENT A C C E S S. E X P E R T I S E. S E R V I C E. Demographic Changes Reproductive Variables Blended Families Composition Generational Overlap Expansion of Marriage and Definition of Spouse Increased Life Expectancies Conception In Utero Ex Utero Inter Vivos Posthumous Husband His sperm Donor sperm Wife Her egg Donor egg Pregnancy Wifes womb Surrogates womb

54 EXPERIENCE THE RIGHT PARTNERSHIP Click here 54 STATEMENTS OF INTENT A C C E S S. E X P E R T I S E. S E R V I C E. 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 grantors view on modification and termination Public Policy Limitations

55 EXPERIENCE THE RIGHT PARTNERSHIP Click here 55 STATEMENTS OF INTENT A C C E S S. E X P E R T I S E. S E R V I C E. 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

1 EXPERIENCE THE RIGHT PARTNERSHIP Dynasty Trusts: Long Term Trust Design R. Hugh Magill Executive Vice President & Chief Fiduciary Officer © 2013 The.

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1 EXPERIENCE THE RIGHT PARTNERSHIP Dynasty Trusts: Long Term Trust Design R. Hugh Magill Executive Vice President & Chief Fiduciary Officer © 2013 The.

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Presentation on theme: "1 EXPERIENCE THE RIGHT PARTNERSHIP Dynasty Trusts: Long Term Trust Design R. Hugh Magill Executive Vice President & Chief Fiduciary Officer © 2013 The."— Presentation transcript:

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