If you would like to provide for multiple generations of heirs, one of the best options to achieve that goal is through a Dynasty trust. Gifting assets to a properly-structured Dynasty trust has many advantages, including asset protection, tax planning opportunities, and maintaining family control from beyond the grave. Although complicated, a dynasty trust is a powerful estate planning tool to preserve wealth and ensure your legacy will continue for generations to come.
Death and Taxes
The tax system imposes both an estate and gift tax whenever wealth transfers to the next generation. If you try to avoid the estate tax by transferring wealth directly to another generation, such as grandchildren, an additional tax, called the generation-skipping transfer tax, is imposed. The current federal estate and gift tax rate is 40%. The generation-skipping transfer tax rate is an additional 40%. That obviously can take quite the bite out of your family’s wealth.
Tax reversion 2026 (or sooner)
The Tax Cuts and Jobs Act (TCJA) doubles the amount that can be passed to heirs without being subject to estate and gift taxes to $11.58 million (2020) for a married couple. However, the thresholds are in place only until 2025. Many families use this temporary higher exemption by funding dynasty trusts to ensure their offspring’s financial futures. Tax rates will increase, and the estate exemption will most likely decrease, so now is the perfect time for a Dynasty Trust.
What is a dynasty trust
A dynasty trust, also called a generations-skipping trust, is an irrevocable trust that lasts longer than one generation below the Grantor. The two main benefits of a Dynasty Trust are it allows the transfer of wealth from generation to generation, with minimal exposure to federal taxes while maintaining some control after the Grantor is long gone.
The Grantor is the person who creates trust and decides what property to include and who the beneficiaries will be. Irrevocable means the Grantor has no control over the assets. However, the Grantor can specify how the trust is managed through distributions to beneficiaries. The Grantor can place significant restrictions regarding where the money goes and how it gets spent.
How long does a Dynast Trust Last?
In some states, a Dynasty Trust can last for several generations or hundreds of years without being forced to pay assets to beneficiaries or taxes to the IRS multiple times. Not all states allow these extended periods. The trust’s lifespan isn’t the only consideration when choosing which state to create a Dynasty Trust. If you’re trying to avoid Federal income tax, you should also try to prevent state tax. Several states do not tax trusts. However, due to the ever-changing state tax laws, you should consult an attorney to ensure the state’s home of trust is appropriate.
Reasons to consider a dynasty trust
Dynasty trusts have many unique benefits that make them attractive. There are two types of advantages, tax benefits and family benefits.
- Generation-Skipping Transfer Tax (GST) Exemption: The GST tax is imposed on assets transferred to heirs more than one generation below the Grantor, or unrelated persons more than 37.5 years younger than the Grantor, that exceed the exemption limit of $12.92 million per individual (2023). The GST tax’s purpose is so the transferor cannot avoid transfer taxes by “skipping” a generation. Remember, the GST is an additional 40% tax levied on top of the gift and estate taxes. A Dynasty trust takes advantage of the GST exemption to shift that amount of wealth out of the transfer tax system.
- Valuation discount: Another benefit of planning with a Dynasty trust is that property transferred to a Dynasty Trust is often entitled to a valuation discount for gift tax purposes because the trust beneficiaries will not benefit from the property for many years. Therefore, they are less valuable, so more assets can be moved into the Dynasty Trust without surpassing the amount you can give free of gift taxes each year. Three factors determine the value of the discount, How much income or financial benefits the Grantor will receive from the trust, how long the Grantor will benefit from the trust’s property, and the current interest rates. The more the Grantor personally benefits from the trust, the less value it has to the ultimate beneficiaries, and therefore the less its value for gift tax purposes.
- Avoid double estate taxation: If you leave assets to beneficiaries without a trust, your estate could be subject to estate tax. Those same assets could be subject to estate taxes a second time when your beneficiaries pass, and so on. However, those assets are excluded from the estate tax calculations for your and future beneficiaries’ estates in a Dynasty Trust. The trust assets remain in the trust, not your beneficiaries’ estates.
- Defective Dynasty Trusts Bonus: Although this idea is beyond the blog post’s scope, there is a way to add another layer of tax goodness to the mix. If the Grantor owns the trust assets for tax purposes, then the Grantor is responsible for the income tax payments instead of the trust, allowing the trust assets to grow since the assets in the trust aren’t reduced by income taxes. Also, the Grantor’s income taxes reduce the size of the Grantor’s overall taxable estate when calculating estate taxes. A seasoned estate planning attorney is required to set this up correctly!
Dynasty Trust Family Wealth Benefits
- Asset management: Dynasty trusts provide a means for managing assets for the benefit of your heirs, which is beneficial if your children or grandchildren are young, financially unsavvy, or irresponsible.
- Support for future generations: The trust agreement governs the beneficiaries’ income payout and principal distributions. A typical distribution example is to provide for the beneficiaries’ health, education, maintenance, and support called HEMS provisions. You could allow the trustee to consider the beneficiaries’ other assets and sources of income when determining distributions. For example, you could enable distributions to a beneficiary of a certain age for as long as they achieve milestones such as college or trade school or have no criminal record.
- Asset protection: Another benefit of dynasty trusts is that, when appropriately structured, assets inside the trust are protected from creditors, both yours and the beneficiaries’ creditors. For example, if there was a divorce or a legal claim against you or the beneficiaries.
- Avoid Probate: A dynasty trust can also eliminate the need for probate court and the publicity that comes with it.
Downsides to a Dynasty Trust
There are also some potential disadvantages to a dynasty trust.
- Long fiduciary obligation: With dynasty trusts, your trustee must serve in that role for an extended period. Practically speaking, it’s best not to select an individual because your trust will outlive multiple generations. The best solution is to appoint a professional fiduciary as a trustee. That, along with careful drafting, can ensure continued professional management.
- Lack of flexibility: Dynasty trusts may exist for multiple generations. There could be events or unforeseen circumstances that the trust cannot address. No matter how hard you try, you can’t plan for every future situation your beneficiaries might encounter. Each state has laws that govern the ability to modify trust provisions. So some flexibility should be taken into consideration.
As you can see, a dynasty trust is a powerful estate planning tool to protect your wealth from taxes and preserve it for the use of future generations. However, creating one is not easy. Talking to a CERTIFIED FINANCIAL PLANNER®, professional estate planning attorney, to determine if a dynasty trust is right for you is essential.
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