When people create estate plans, they typically focus on handing down their money and property to their children, grandchildren, and other living heirs. But some people want to leave behind a more enduring legacy. For those interested in multigenerational wealth transfer, a dynasty trust could be the answer.
A dynasty trust is an irrevocable trust that offers the tax minimization and asset protection benefits of other types of trusts, but unlike a trust that ends with outright distributions to your children or grandchildren, a dynasty trust can span more than two generations. Also known as a perpetual trust, a dynasty trust theoretically can last forever – or at least for as long as trust money and property remain. Because the trust could last for many years, and the rules generally cannot be changed once the trust is created, a dynasty trust must be set up with great care.
How Does a Dynasty Trust Work?
A dynasty trust starts the same way as any other trust. The trust’s creator (i.e., the grantor) transfers money and property into the trust, either during their lifetime or at the time of their death, in which case the trust is a testamentary dynasty trust. Regardless, as an irrevocable trust, once the dynasty trust is funded, it is set in stone. It cannot be revoked, and the rules the grantor sets for the trust can only be altered under certain state statutes governing trust modifications.
Who Should Serve as Trustee of a Dynasty Trust?
One role that the grantor must seriously consider is who will act as the trustee. It is common for the grantor of a dynasty trust to name an independent trustee, such as a bank or trust company, to serve in this role because they can administer the trust for as long as it lasts.
While it is possible to choose a beneficiary of the trust to serve as the trustee, this raises potential tax and creditor protection issues. A beneficiary-controlled trust can have income and estate tax consequences depending on the terms of the trust and the scope of the beneficiary’s powers. Not only does a beneficiary’s ability to control the trust affect the degree of asset protection the trust provides the beneficiary, but it also risks family wealth to misappropriation. In addition, a corporate trustee, like the dynasty trust, has an indefinite legal life, allowing for uninterrupted administration across generations. Corporate trustees typically charge an annual fee based on the amount of money and property in the trust.
Who Should Use a Dynasty Trust?
Estate planners like to remind people that trusts are for everyone, not just the wealthy. However, an exception to this general rule can be made for the dynasty trust. While you do not need to have the dynastic aspirations of the Medici family or the House of Windsor to set up a dynasty trust, most of the time, it is used by families with significant wealth.
There is no law that says you need a certain amount of money to set up a dynasty trust. But practically speaking, a dynasty trust only makes sense if you have money and property that will last for two or more generations (although this depends on the monetary needs of your beneficiaries and how fiscally responsible they are). Grantors who are thinking about multiple generations after their children set up dynasty trusts.
Another way to utilize a dynasty trust, other than handing down money to future generations, is to keep a family business in the family. Anyone who owns a family business is probably familiar with the dismal statistics about their longevity (e.g., 40 percent transition to a second generation, 13 percent make it to a third generation, and just 3 percent survive to the fourth generation or beyond). Using a dynasty trust, the grantor can place shares of the business in the trust to benefit multiple generations of beneficiaries. The trustee could be a professional trustee that can manage business affairs and maintain the continuity of operations, while the beneficiaries benefit financially from the business. The grantor can include terms that help ensure the business is run competently, such as requiring the trustee to have an advisory council that effectively serves as a board of directors.
Tax Benefits of a Dynasty Trust
Part of keeping your legacy in the family is keeping your hard-earned money from being taxed. The federal estate tax exemption amount of $12.06 million per individual in 2022, or twice that amount for couples) can be used to fund a dynasty trust so that the money and property transferred directly to your grandchildren will not be subject to gift or generation-skipping transfer (GST) taxes. By placing accounts and property in a trust and timely filing a gift tax return to allocate appropriate tax exemptions to the trust or pay some amount of wealth transfer tax, those items are not included in your taxable estate. This goes for your beneficiaries as well, as long as the trust is fully exempt from GST tax.
Trust funds may be used to pay a beneficiary’s living expenses or invest in a home for the beneficiary’s benefit without contributing toward the beneficiary’s taxable estate. Even better, creditors and divorce courts cannot reach accounts and property that you leave to your loved ones in a properly drafted dynasty trust. You and your beneficiaries will not receive these benefits if you give them money outright.
Dynasty Trusts Not Available in Every State
The rule against perpetuities is a common law rule that limits the duration of controlled property interests, including interests in trusts. Although not written specifically with trusts in mind, the rule against perpetuities effectively prevents people from using legal instruments such as deeds and trusts to control the ownership of property for many years after they have died. But the rule is notoriously difficult to decipher, leading many states to modify it to extend the applicable term or get rid of it altogether. Keep in mind, though, that you may be able to set up a trust in a state that you do not reside in with the help of an experienced estate planning attorney.
Creating Your Dynasty
Among the items to be discussed are the selections of the trustee and beneficiaries, tax and creditor protection considerations, state laws on perpetual trusts, and how a dynasty trust fits into your overall estate plan.
At Cheever Law, APC, we don’t just draft documents; we ensure you make informed and empowered decisions about life and death for yourself and the people you love, starting with a valuable and educational Family Wealth Planning Session. The Life & Legacy Planning Session will allow you to get more financially organized and make the best choices for the people you love. If you have already completed your estate plan, we will review that plan at your Life & Legacy Planning Session (aka Family Wealth Planning Session) to ensure that it will work the way you intend and address any holes or gaps that may be present if circumstances have changed since you executed your plan.