One of the major complications facing aging individuals is the passing down of wealth to the next generation without creating large tax implications. The dynasty trust is a straightforward estate planning technique that can substantially reduce taxes.
The dynasty trust is a long-term trust, spanning the length of years after the death of the creator of the trust, used to pass wealth from generation to generation without incurring the transfer taxes that are usually associated with gift tax, estate tax and generation skipping tax. Assets that are transferred into a dynasty trust are subject to tax when the transfer is made and only if the assets exceed the federal tax exemption limits. If adequately funded and managed, a dynasty trust can ensure financial support for generations without taxation and without the uncertainty of what will be done with the assets.
Historically, wealthy heads of family would create trusts that utilized the distributions to the decedent beneficiaries for maintenance and would then distribute the principal to the grandchild upon death. Once it was realized that this allowed estate taxes to essentially skip a generation, Congress enacted the generation skipping transfer tax. Generation Skipping Trusts were first introduced in the late 1970s that went after direct gifts as well as transfers to trusts for the benefit of an unrelated person who are more than one generation younger than the donor. With this came an exemption. In 2018, the exemption is $11.18 million (single). Since dynasty trusts are taxed only on the amount of transfer above the exemption allowed for a Generation Skipping Trust, wealthy families can pass along at least the exemption amount to their heirs tax-free. Furthermore, the gains on the transferred assets are also exempt from gift and estate taxes. Dynasty trusts are also irrevocable, ensuring that the trust stays out of the grantor’s estate at death. The beneficiaries also do not retain control of the trust assets, and they are therefore not counted toward the beneficiaries’ taxable estates.
An additional benefit of dynasty trusts is that they can shield assets from liabilities that may arise for the beneficiaries. Because the assets are not owned or controlled by the beneficiary, they cannot be included in marital estate for divorce process or child support, subject to creditor claims, or civil judgments. Temporary trusts cannot provide this same level of protection. As temporary trusts are predetermined at its creation, it can be terminated based on the age of the beneficiary, after a certain number of years, or a variety of other instances that may not suit the needs of the beneficiary.
When setting up a dynasty trust, it is important to also look at the state. Many states do not allow for trusts to live on past the death of the grantor and have set up limitations also known as Rule Against Perpetuities. Certain states, such as Alaska, Delaware, Nevada, New Hampshire, and South Dakota have done away with perpetuity rules. An additional cause for concern during the creation of the trust is if the state has personal income tax. If so, the distributions to the beneficiaries may create an income tax liability. Any non-distributed income of the trust will generally be subject to income tax in the state of jurisdiction as well. Choosing a state without income tax to establish the trust in can lend itself to additional tax benefits to future generations as well.
Dynasty trusts can also be set up to provide for charitable giving. There are two ways in which a charity can benefit from a dynasty trust. The first is simply to have the charity be a named beneficiary of the trust. Be sure to structure the trust so that the charity only receives the trust assets not used by the decedent beneficiaries. This puts family first and any remainder goes to the charity. Another option is to couple the dynasty trust with a charitable lead trust. This allows for guaranteed charitable giving alongside the distributions to descendants.
One of the great benefit to a dynasty trust is the ability to dictate much of the requirements of the distributions. The wording can dictate amounts due to charities, maintaining good credit by the beneficiaries, medical and education distributions, support and the like. This allows for continuation of the values of the original grantor. The verbiage of the trust ensures that the distributions are made and are generally for immediate use. There are times that it may be desired for the trust to provide a loan to a beneficiary for additional capital, or to directly invest in an asset for the beneficiary. While a beneficiary can serve as trustee, for the continued assuredness of the grantor’s vision, money lending, better asset protection due to distance from the assets, and prevention of establishing a new trustee upon death, an institutional trustee is generally preferred. It is important to be sure that the trust contains language regarding the hiring and firing of a trustee, as well as having provisions regarding when, if ever, a beneficiary can become a trustee.
The benefits of a dynasty trust is that it allows you to preserve your wealth for future generations, continue to give charitably after death, provide asset protection, and save on taxes. The limitations on flexibility during your own and future generations lifetimes can be a disadvantage over more temporary trusts. There are many ways to fund and structure a dynasty trust to ensure continued support for the family. As with all types of estate planning, deciding whether to incorporate a dynasty trust is a big decision. Careful evaluation of your estate and your goals should be made with your financial advisors.