Rules Against Perpetuities: Modern Trend

The power of alienation is the power to transfer assets. The disposal of assets, free of restraints, is considered necessary for the efficient allocation of economic resources. Those who can use the resources most productively will be willing to pay the most for it and, hence, would obtain those assets and use them for their most productive use. However, future interests on assets can impede any transfers, since multiple beneficiaries have an interest in the property, and none of the beneficiaries can convey an absolute title to the assets without the consent of the other beneficiaries.

Although future interests held by living, knowable beneficiaries are transferable, interests held by unborn or unascertainable beneficiaries are not, and some beneficiaries may be restricted against transferring their interest by the creating document, such as by spendthrift clauses.

The rule against perpetuities (RAP) law was developed to prevent the extension of dead hand control far into the future, since it may restrict the alienation of property for the duration. Under the rule against perpetuities, a future interest must vest within the permissible period of the measuring life + 21 years; if the future interest may vest sometime after the permissible period, courts have ruled the interest to be void.

The use of a measuring life instead of a specified time made the perpetuities law ridiculously complicated in consideration of its objectives, and mistakes were frequently made by donors or their lawyers in determining what the actual perpetuities period would be since it depends on the measuring life + 21 years. A future interest was sometimes found to be invalid based on unlikely, or sometimes, impossible, scenarios, or the person represented by the measuring life had died prematurely or additional children were born after the beginning of the permissible period.

Consequently, the Uniform Law Commission has promulgated the Uniform Statutory Rule Against Perpetuities (USRAP Summary), which some states have adopted, that modifies the perpetuities period to either 90 years or the measuring life + 21 years, whichever is longer, and if the rule is violated, it allows the courts to reform the document so that it complies with the rule. The 90-year period eliminates the need for a measuring life; hence, it obviates the need to account for the measuring life and prevents the permissible period from being shortened by a premature death of the referent person. The 90-year period was chosen because it was considered the best approximation to the measuring life + 21 years developed under common law and because most future interests did actually vest within 90 years.

Cy Pres and Wait-and-See Reformations

The RAP invalidated future interests based only on possibilities, no matter how improbable that the future interest would actually vest after the permissible period. Consequently, the states and courts have developed new law concerning the rule, with the objective of either conforming the future interest so that it satisfies the rule, applying the rule so that it does not conflict with the vestment of the future interest, or abolishing the rule.

The law has developed 2 approaches to reforming the rule: the cy pres approach and the wait-and-see approach.

Under the cy pres approach, the court modifies a will or trust document that violates the rule only as much as is necessary to comply with the rule. Hence, this method of construction not only conforms the document to the rule but also carries out the intent of the donor as closely as possible. A common example of this is a future interest for a descendant of one holding a life estate, but with a contingency that the beneficiary reach an age exceeding 21; here, the court simply reduces the age to 21 — the beneficiary still gets the gift, which is what the donor intended, but gets it at an earlier age to comport with the perpetuities rule. Another common reformation by the courts is to add a saving clause to the document, thereby ensuring that the rule is not violated.

The wait-and-see approach actually began as a statute passed by Pennsylvania in 1947, which stated:

"Upon the expiration of the period allowed by the common law rule against perpetuities as measured by actual rather than possible events, any interest not then vested and any interest in members of a class the membership of which is then subject to increase shall be void.…" Pa. Stat. Ann. 20 §6104(b)

Rather than declaring that a future interest is void based on the document creating it, the courts wait and see if the rule is actually violated. The practical application of the wait-and-see approach is that if an interested person does not challenge the interest after the expiration of the period, then the future interest survives.

However, the jurisdictions differ as to how to remedy a violation of the rule. Most jurisdictions — and the Uniform Statutory Rule Against Perpetuities — allow the court to reform the document so that the rule is not violated, but some jurisdictions void the interest entirely, causing it to revert back to the donor or her estate.

Abolition Of The Rule Against Perpetuities

The modern trend is to abolish the Rule Against Perpetuities because of its complexity, but mostly to attract trust business to those states abolishing the rule. The arguments for abolishing the rule is that flexibility of property disposal is achieved through powers of appointment and by the easy termination and modification of trusts by beneficiaries with court approval, and by giving trustees the discretionary power to buy and sell assets; hence, property is not necessarily tied up during the perpetuities period.

The main purpose for using trusts, aside from the greater control of disposing of property by a deceased grantor, is a savings of federal wealth transfer taxes — specifically, gift, estate, and generation-skipping transfer taxes. Trusts are often funded with money exempt from these taxes, and as long as the trust exists, it can benefit successive generations without paying transference taxes on the trust property, which is the basis of dynasty trusts (aka perpetual trusts).

Avoiding federal wealth transfer taxes is simple. For example, the grantor of the trust transfers his tax-exempt amount to the trust, grants his daughter the life income from the trust with a special power of appointment to appoint the trust's assets to someone else, either outright or in further trust. The daughter then appoints the trust income in her will to her children and also gives them the same special power of appointment, who can, then, do the same thing for their children, etc. Hence, all estate, gift, or generation-skipping transfer taxes are avoided.

Dynasty trusts are based on 2 tax benefits that mainly benefit the wealthy, allowing dynasty trusts to avoid wealth transfer taxes:

  1. Each individual has a unified tax exemption that applies to either gifts or estates, and a separate exemption for GST taxes. both exemptions can be applied to property placed in the trust so that no transference tax liability is ever incurred on the trust property, even when it is finally distributed to beneficiaries.
    • For 2011 – 2012, the unified exemption for gifts and estates is $5 million and the exemption for GST taxes is also $5 million, or, for a married couple, $10 million for both exemptions.
  2. Either the trust can own the property outright for the duration of its existence or tax free transfers can be achieved using special powers of appointment, which are tax free because the holder of a special power of appointment is not considered the owner of the appointive property; hence, the appointive property is not subject to estate or GST taxes.

Yesteryear, these trusts were limited in duration by the rule against perpetuities, but can now last indefinitely in those states that have abolished the rule concerning interests in trust.

States That Have Abolished the Rule Against Perpetuities
  • Alaska
  • Delaware
  • District of Columbia
  • Idaho
  • Illinois
  • Kentucky
  • Maine
  • Maryland
  • Michigan
  • Missouri
  • Nebraska
  • Nevada
  • New Hampshire
  • New Jersey
  • North Carolina
  • Ohio
  • Pennsylvania
  • Rhode Island
  • South Dakota
  • Tennessee
  • Utah
  • Virginia
  • Wisconsin
  • Wyoming

States are abolishing the rule, not because the rule was not beneficial for the economy, but merely to attract trust business. Because anyone can set up a trust in any state, regardless of where the settlor lives, more states will be pressured to abolish the rule, to keep their trust business, which can be substantial, especially since many trusts own financial assets, which, unlike realty, can easily be transferred to any state. In keeping with the objective of keeping trust business, some states have only abolished the rule against perpetuities as it concerns interests in trusts.