Wealth transfer does not have to be exceptionally complicated nor prohibitively expensive. But you do need to plan more than just telling your family in advance whom you’d like to have inherited the car, house, or bank accounts. Estate planning exists as a branch of legal tools to help those with an estate of any kind – be it modest or extravagant and multinational – bequeath their wealth as efficiently as possible, with a few unexpected costs and hassles as possible.
Among the many ways an estate can be prepared for dissolution after death is the trust: a legal entity that holds assets, properties, and accounts in trust on behalf of a benefactor (the owner) transferring wealth to a beneficiary (their next of kin, grandchildren, friends, or in some cases, even themselves). Not all trusts are created equal. There are distinct differences that allow certain trusts to excel in protecting assets from creditors, minimizing tax costs, or creating a long-term fund for your great-grandchildren.
Knowing how trusts work and knowing what kind of trust you might need to manage your wealth beyond death best is key to the estate planning process. For those interested in multigenerational wealth or preserving the family fortune for more than two or three generations, effective trust planning is important: and the eponymous dynasty trust is a great place to start.
What Is a Dynasty Trust?
As the name implies, a dynasty trust is a trusted entity created and defined by the intent to preserve wealth throughout multiple generations while greatly limiting or eliminating certainly expected tax hits that can occur as money changes hands after death, such as the estate tax, generation-skipping transfer tax, or gift taxes.
In other words, a dynasty tax is the most effective way to preserve and build wealth across multiple generations with as little of a tax impact as legally possible. Part of what sets a dynasty trust apart from other trusts is that most trusts have an expiration date, or more accurately, aren’t meant to last that long. Trusts are more than just a way to transfer wealth after death.
Unlike wills, which are read out, executed, and dissolved within less than two years in most cases, conventional trusts can last as long as 21 years after the death of the last beneficiary or well over a hundred years after the death of the grantor, depending on state and federal rules at the time. Dynasty trusts can be written and managed to last for as long as the surviving beneficiary cares to manage and uphold them.
In a way, these trusts are self-perpetuating, although they need a little maintenance to ensure that they continue to remain active. To that end, dynasty trusts are meant to last long after death – we’re talking about indefinite wealth management in the ideal scenario. In reality, a dynasty trust can easily be managed for multiple generations if each generation takes care of its respective legal responsibilities and upkeep.
However, this can only work in certain states as most US states have rules against infinite duration trusts. These rules are called Rules Against Perpetuities, or RAP. States that have done away with these rules or greatly extended them past the normal limit include Alaska, Delaware, Nevada, South Dakota, and Washington, to list a few examples.
What You Need to Know
Dynasty trusts have simple theoretical anatomy. The elements you need to be aware of include:
- Grantor or trustor. This is the original creator of the trust and the owner of the trust’s contents before being funded into the trust.
- Beneficiaries. These are the people who will be receiving income from the trust, and depending on the terms of the trust, they will also receive respective portions of the trust’s principal or original contents. Trust income can be anything from rental payments to royalties. Dynasty trusts are often funded with assets that do not incur income taxes, such as tax-free municipal bonds and dividend-less stocks.
- Trustee. This is who will be managing the trust on behalf of the grantor and their beneficiaries. This does not have to be a person. It can be a bank or any other reputable, long-standing financial institution. In the case of a dynasty trust, most grantors decide to partner with a financial institution instead of naming a human trustee and multiple successor trustees to ensure that the trust will continue to be managed long after they and their beneficiaries have passed away.
- Trust document. This is a witnessed, signed, and notarized document that explains the trust conditions and typically includes an asset list detailing its contents. This asset list is, under most circumstances, not enough to actually mean that everything on the list is also within the trust. Any assets meant to be placed in trust have to be separately funded into it by rewriting the asset’s respective ownership documents. The trust document itself can only be amended if the trust is revocable. Irrevocable trusts cannot be amended. Dynasty trusts are irrevocable.
- Trust entity. This is the intangible trust itself, a named legal entity that can hold assets and property under its name and the conditions of the trust document. Trusts are immensely flexible and can be written to dictate conditions for the bequeathment of income and assets. For example, a beneficiary may only receive their respective portion of the trust if they continue to finish their education or once they reach a certain age. Such conditions and flexible demands cannot typically be enforced by a will.
There are hard limits on how a dynasty trust can be funded without incurring tax costs. These correspond with the total federal lifetime gift and estate tax exemption limit, which is $11.7 million in 2021. This limit is subject to change – it currently changes annually to adjust to inflation but may be increased or reduced more drastically, depending on lawmakers. Your lifetime gift tax exemption limit may also be smaller than $11.7 million if you have already exceeded the annual gift tax exemption at any given point ($15,000 in 2021).
Once the grantor funds the trust up to the current estate tax exemption limit, they can name their respective beneficiaries and conditions and make the trust irrevocable. This means they have no access to anything funded into the trust, and the trust becomes wholly separate from their own estate. This also means the trust no longer counts as part of their taxable estate. This is why irrevocable trusts are an effective way to reduce the size of your taxable estate.
That being said, there are two other sizeable considerations for why you might want to create a dynasty trust.
In addition to gift and estate taxes, the federal government can levy a generation-skipping transfer tax on any estate that passes wealth onto grandchildren and great-grandchildren, i.e., skipping a generation. The GSTT exemption limit is the same as the estate tax exemption limit, but more interestingly, trust assets are currently protected from this tax. This means you can use a dynasty trust to reduce the size of your taxable estate and protect your assets from the GSTT.
Secondly, while dynasty trusts are irrevocable, they can be written to keep a tangential link to the grantor to ensure that any income taxes that are eventually incurred are paid by the grantor rather than the trust itself. This is a so-called grantor trust. Grantor trusts are recognized by the IRS as such in cases where a grantor reserves some control over their trust, be it revocation powers, the right to control how beneficiaries use their wealth, a level of administrative control, or other rights.
Trusts Aren’t Ideal for Everybody
Dynasty trusts are ideal for minimizing the tax impact of transferring wealth across multiple generations while ensuring that your loved ones benefit from that wealth’s continued growth within the trust. Most estate plans do not require trust documents as extensive and complex as a dynasty trust. But these are conditions that apply only to the country’s most privileged.
Many estate plans can do well without any trust, to begin with. But every American owes it to themselves to have contingencies of some sort. Estate plans also allow you to dictate your healthcare and financial decisions in your final hours, transfer guardianship over minor children and other dependents, or prepare a fund for your special needs child. Consult a professional to learn more today.